Soaring oil prices have yet to derail economy

John W. Schoen Senior producer • Profile • E-mail

With oil prices touching new highs above $88 a barrel Tuesday, the financial markets and the economy seem to be largely unfazed — at least so far. And despite the rapid run-up in the cost of crude from about $60 just two months ago, motorists have been watching pump prices fall. What’s going on here?

The question is all the more puzzling because, while strong demand and limited production have kept oil supplies tight for much of the decade, current inventories appear to be adequate to keep the market supplied. U.S. inventories have been falling recently but remain above the five-year average level for this time of year.

Crude oil deliveries to refiners, meanwhile, have been declining as they usually do this time of year when demand for gasoline makes its seasonal move downward following the end of the summer driving season. Retail gasoline prices have fallen from the peak of $3.22 a gallon in May to $2.76 a gallon as of this week, according to the Energy Department.

To be sure, some consumers are beginning to feel the pinch. The price of heating oil is expected to rise more than 16 percent this winter, although a mild winter could send prices tumbling again as they did last January.

“Our (crude) inventory situation is pretty much in line with where it’s been,” said George Winslow, a heating oil dealer in Manchester, N.H. “So you scratch your head and say, ‘Why is the price where it is?'”

One big reason for this apparent paradox is that much of the run–up in prices is being fueled by demand from investors, not consumers. Investors have stocking up on oil futures for a variety of reasons. Earlier this summer, many were betting a strong hurricane or two in the Gulf of Mexico could lead to Katrina-like supply cutoffs to the U.S. market.

More recently, worries have centered on events in the Middle East.  Published reports that the U.S. was considering attacks on Iran’s nuclear facilities have helped sparked fears of a potential supply shortage, said Bill O’Grady, an energy analyst at A.G. Edwards.

“There are a number of things pointing to that possibility,” he said. “Thus, it makes sense to buy oil as a protection against such an event.”

O’Grady says that investors have another reason to stock up on oil: as a hedge against inflation. After recently cutting interest rates to ease a widespread credit crunch — even as inflation remains at the high end of the Federal Reserve's supposed target range — the central bank has shifted its stance to promoting economic growth. That has some investors conscerned about a possible resurgence of inflation, said O’Grady.

“That tells you tell own real assets,” he said. “And the queen of real assets is oil.”

Though many of those who are buying oil in the futures market never intend to actually use it, the impact is very real for those who do. Still the impact on the global economy has been fairly mild — at least so far.

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