Will crude bubble burst?

Crude oil has surged through its unofficial US$75 per barrel target to its highest point this year, but the factors driving prices higher are not bringing comfort to producers.

While crude oil has surged through its unofficial US$75 per barrel target to its highest point this year, the factors driving prices higher are not bringing comfort to governments of oil-producing nations and analysts doubt the upwards momentum can be maintained. "Crude is gaining purely on sentiment now, unlikely to sustain above $75," said Victor Shum, a senior principal at the energy consultant Purvin & Gertz.

Touching $75.12 yesterday in early New York trading, crude extended a five-day winning streak, buoyed by a weak US dollar and surprisingly strong Chinese trade data. Meanwhile the dollar has dropped to a 14-month low against a basket of currencies, boosting investor interest in dollar-denominated commodities such as oil and gold. Reflecting that view, gold set another record of $1070.80 per ounce in London yesterday.

Gathering optimism about the economic recovery has also strengthened crude in tandem with equities. OPEC on Tuesday raised its forecast for global oil demand, citing an improving outlook for the global economy. Still, worldwide stockpiles of crude oil and petroleum products remain near record levels, while OPEC members with combined excess producing capacity approaching 7 million barrels per day (bpd) have been slackening their adherence to reduced output quotas. That feeds concerns that the current glut of oil could persist until late next year, making prices vulnerable to bad economic news.

"There's a lot of positive sentiment right now, but that's largely driven by the softer dollar," Mark Pervan, a senior commodity strategist at ANZ Bank in Melbourne, told Reuters. "Whether the rally is sustainable depends on further dollar weakness." The US currency has been under pressure from expectations that the US Federal Reserve Bank will keep interest rates low to speed the country's sluggish economic recovery. The possibility also exists that, as economic power shifts from East to West, the dollar could eventually be dethroned as the world's reserve currency.

That raises problems for Gulf oil exporters, including Saudi Arabia and the UAE, which peg their local currencies to the dollar. While higher crude prices may increase government revenues from oil exports, a lower dollar offsets any benefit to the state by raising the cost of imports and stoking local inflation. By the same token, the cost of developing oil supplies for the future is forced higher as dollar price tags for imported labour, services, equipment and construction materials increase.

As crude skidded towards a seven-year low of $32.40 per barrel last November from a record $147 the previous July, the Saudi King Abdullah said a price of $75 would be "fair" for oil producers and consumers alike. However, that suggestion, which quickly gained support from OPEC and western oil consumers, was based on the expectation that oil development costs would fall in response to the deepening financial and economic crisis.

Now, some key oil exporters may find they need crude to exceed $75 per barrel to justify continuing huge investments in future supply. That suggests the dream of achieving a stable, "fair" oil price may turn out to be just a mirage. @Email:[e-mail]