Sunday, April 10, 2011

What is driving the price of oil to a 2 ½ year high?

On Friday, a barrel of Brent crude oil traded up to $126 in Europe (+34% YTD), while oil in the U.S. traded at $113 a barrel (+23% YTD). Dynamics contributing to the price increase include: 1) increased global demand for oil, 2) damaged oilfields in Libya, 3) uncertainty about elections in Nigeria (a large oil exporter), 3) possible increased gasoline demand during the summer driving season, 4) unresolved U.S. government budget issues and 5) speculative commodity trading activity.

MY TAKE: If oil prices remain high, inflation expectations will likely increase, which could result in lowering consumption and slowing the economy. An important indication of the potential economic impact will come from company managements in the coming weeks as they report their earnings. NOTE: Given that U.S. housing prices and hourly wage trends remain weak and the government budget environment remains challenging, investors should consider the potential for both inflation (short term) and deflation (longer term).

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