Last Tuesday, the oil markets rose above $51/bbl, where it has since stayed. A current projected cold spell in the US North East will continue this trend. There was an article on CBS.Marketwatch that this price hike was unexpected. In addition, the traditional measures used for oil price are not working.
The answer is actually pretty simple. Oil prices are high for three reasons. First, oil is produced in politically unstable countries. Secondly, the supply/demand relationship is very tight. This simply means that there is little excess supply capability that producer's can use in case of an increase in demand. Third, the medium used to price oil is losing value.
Why does a cheap dollar = expensive oil? Let's use a simple example to illustrate the point. Let's say oil is $10/bbl and the dollar is dropping 10%/year. That means that $10 on January 1 = $9 on December 31 -- 10% of $10 = $1. So, while an oil seller is
technically getting $10/bbl, his profit is actually dropping.
Last year, the dollar index (the value of the dollar verses a basket of currencies) dropped by roughly 10% from October to December. Oil prices spiked in October, but fell towards the end of the year. Currently, oil is trading above $50/bbl. This correlation is not 100% accurate. But it is hardly a coincidence considering the fact that oil is priced in dollars. The dollar's drop is obviously a factor.
In addition, over the last year, Russia floated the idea of converting oil trading to Euros. This idea quickly died. There is also a theory the Iraq war was started because Iraq was thinking about converting its oil trading to Euros.
In summation, expect more of the same. Oil producer's will want more expensive oil to compensate them for the drop in oil's medium of exchange.
Thanks, George.