Economy, not Physical Markets, Driving Oil Prices

The U.S. Department of Energy last week issued one crude oil loan from the Strategic Petroleum reserve to Marathon Petroleum Co. as gulf operators dealt with the effects of Hurricane Isaac. The dual effect of the Category 1 storm and the Labor Day holiday in the United States caused a brief spike in energy prices. More than 80 percent of the production platforms in the Gulf of Mexico closed as a result of the storm, causing a ripple effect in the market for petroleum products. Western economies had already expressed concern about the economic fallout from high energy prices. A recent statement from the G7, however, and continued growth in the Chinese economy may suggest there are broader geopolitical concerns at stake than physical market issues.

The U.S. Treasury Department issued a statement on behalf of the G7 noting the "substantial" economic risks of increasing oil prices. G7 members called on oil-producing economies to add more crude to markets to meet rising demand.

"The current rise in oil prices reflects geopolitical concerns and certain supply disruptions," the statement read.

The Treasury Department said G7 members were ready to call the International Energy Agency to action to ensure markets were flowing. IEA Executive Director Maria van der Hoeven, however, said that energy markets were "well-supplied." Hurricane Katrina in 2005, a much stronger storm, prompted a strategic petroleum release, but by Friday, companies like Exxon Mobil had already started the process of restoring operations in the Gulf of Mexico as the remnants of Isaac moved inland.

The U.S. Bureau of Safety and Environmental Enforcement said nearly all of the oil production in the Gulf of Mexico was shut in by Isaac. The temporary restriction represented 95 percent of the daily production from the region. In mid-August, however, the IEA had already lowered its demand forecast from 900,000 barrels per day this year to 800,000 bpd in 2013 because of sluggish economic growth, suggesting markets could withstand the closure in the gulf.

Outside the G7, the Chinese economy is expecting a slowdown in its own right. China's economy was expected to grow 0.1 percent to 8.1 percent in 2013, down from previous predictions of 0.5 percent growth.  Analysts had said a bearish Chinese economy was "not good news" for the international energy market. For the last 20 years, the Chinese economy has been the driving force behind much of the energy markets. At least some of that slowdown in China, however, was because of a weak Western economies.  The French economy again moved toward recession and the IEA put U.S. economic growth at 2 percent for next year, a 0.3 percent decline from the previous report.

Predictions of a release from the SPR brought a frenzy of reports criticizing the heightened reaction to rising energy prices. The IEA had said markets are not only well-supplied, but the agency's assessments of long-term economic growth suggest recent increases in oil prices may be temporary. The G7 statement may have been a political move that reflected the economic outlook for member states, however. Crude prices fell briefly in reaction to the G7 statement, but rallied again after U.S. Federal Reserve Chairman Ben Bernanke said injecting more money into the economy could fuel growth. The all-options-on-the-table approach by the G7, coupled with market reactions to Bernanke's speech, suggest that, at this point, there are few physical market mechanisms at play in recent trends for oil.

By. Dan Graeber of Oilprice.com