Oil prices may finally be getting acquainted with reality. After clipping an eight-month high earlier today, crude prices tumbled more than 2% to close below $70 a barrel.
Given the shaky consumer-confidence reading this morning, primarily attributed to higher gasoline prices, a drop in oil prices would be welcome. And it may be in the offing following a 41% gain in prices during the second quarter.
The oil market has not exactly focused on fundamental supply and demand issues during the past couple of years. The price spike to $147 a barrel one year ago looks bizarre in retrospect. The lows of $35 a barrel earlier this year reflected the post-Lehman uber-pessimism.
More recently, the surge in oil prices — up 68% in the last five months — has similarly ignored reality. Oil supplies are rising, global demand is down and inflation fears remain highly theoretical.
Oil bulls have focused on two notions: a weaker dollar and rising demand from China. When the dollar declines, commodity prices tend to rise since they are priced in dollars. Need more of the weak buck to buy the same amount of crude, all things being equal. There is something to this idea, because the dollar has struggled and many expect it to have a rough go amid soaring fiscal deficits.
The China demand notion, however, is far weaker. Even if China demand is rising, the wilting economies of Europe, Japan and the U.S. more than compensate for that demand. Given the still uncertain prospects for these large economies, it’s hard to see how demand will drive oil prices higher.
Intriguingly, Chevron and ExxonMobil started retreating from recent highs earlier in June even as oil prices pressed higher. Maybe those stock moves foreshadowed coming weakness in the oil market. We could see a broader retreat in oil prices, especially if the Green Shoots don’t start blossoming into something more than a hope.
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