Oil: A market that knows no bounds

The oil market knows no bounds: Its price, for now about $70, lurches back and forth, seemingly disconnected from fundamentals, driven more by "paper barrels" than "wet barrels."

"Paper barrels" are the futures contracts that hedge funds, investment funds, pension funds and others trade. They set the tone for the market, which shifts almost as quickly as the sands in a Middle Eastern desert.

"Wet barrels" are the actual production and inventory totals - the real oil that's out in the world. And right now, the world is awash in oil, with inventories at five-year highs and storage facilities straining to find additional land-based facilities to store crude. There's so much surplus oil that oil producers and others have taken to storing large amounts of oil in very large oil tankers at sea.

The world is awash in oil

It's a world that's awash in oil, but you'd never know it from oil's price, currently around $70 per barrel. That's well above oil's historic 150-year real average of about $25-30 per barrel, and certainly above where the price would typically be as a recovery starts following a long, nasty U.S./global recession.

Why is oil's price elevated? Pick your poison, or factor. The weak dollar. The threat of U.S. inflation. Oil as an asset play. Too many gas-guzzling vehicles in the United States. OPEC production cuts. Geopolitical risk. Rising emerging market demand. Global oil production increases unable to keep up with consumption increases in the decade ahead.

Any one of the above factors would be more than sufficient to prompt institutional investors to hit the 'Buy' button triggering those paper barrels, the drivers of oil's price; combine several and one can see why oil would be at $70 per barrel despite so much crude sloshing around that the world doesn't know what to do with the stuff.

Oil Analysis: The above makes the case that oil in the globalization era has been remarkably impervious to supply/demand factors. How else can one explain oil at $70 per barrel and gasoline in the United States at $2.60 per gallon amid a nearly 10 percent U.S. unemployment rate?

Further, the logical extension of the above should not be lost on investors, or on U.S. drivers and businesses: Even large decreases in U.S. oil and gasoline consumption will not guarantee a drop in prices. In other words, the United States has little control over oil's price. From economic stability and national security standpoints, that makes a very strong case for the U.S. to pass a national energy policy to first reduce, then replace, the use of oil with alternative, domestic fuels/energy sources.

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