There was time when I took an active interest in the oil price. I made the classical economic assumption that the price was predominantly set by the ironclad laws of Supply & Demand. Not anymore. I can go for weeks now without knowing what the price is. But my curiosity was renewed yesterday when I noticed that a barrel of oil (NYMEX WTI crude) was now selling for $82! Say what? WTF?

I lost interest in the price of oil when I could no longer ignore the fact that financial considerations, not Supply & Demand, set the price (Bloomberg, July 29, 2010)—

“The oil market is being set by the financial markets,” said Tim Evans,an energy analyst at Citi Futures Perspective in New York. “We’re back to that kind of correlation trade and not paying so much attention to niggly details like rising inventories and rising OPEC production.”

Mouse over the 1m (1 month), 1q (1 quarter), etc. to see the data. Source

In the oil price run-up of 2007-2008, I was interested in those "niggly" details like OPEC production levels. I assumed the price was almost entirely based on them. What a fool I was!

There are two statistical data points of interest. Bloomberg keeps track of both.

The oil price is positively correlated with the S & P 500. For example, Bloomberg reported on July 23rd that— Investors are also shunning oil as prices trade in line with equities, reducing the incentive to invest in crude as an independent asset class, according to Jakob. Oil’s correlation to the Standard & Poor’s 500 Index is 81 percent compared with 54 percent at the end of March, Bloomberg data show. “When the correlations between crude and the S&P index are running at such a high level, there is little added value in trading crude on its own,” Jakob said. “That is chasing away some market interest.”

with the S & P 500. For example, Bloomberg reported on July 23rd that— The oil price is negatively correlated with the dollar. For example, Bloomberg reported on May 19th that— Crude’s 30-day correlation to the dollar is minus 0.94, as the two move in opposite directions 94 percent of the time, the highest level since February, according to data compiled by Bloomberg. A correlation of minus 1 would mean the two always move inversely.

You can easily see that movements in the price of crude have little to do with Supply & Demand fundamentals as typically reflected in inventories. This leads to schizoid reporting of oil price movements. For example, Reuters gave us UPDATE 10-Oil extends gains to new 3-month high ($82) on weak dollar—

NEW YORK, Aug 3 (Reuters) - Oil prices rose for a fourth day on Tuesday, setting a fresh three-month highs above $82 per barrel as the dollar fell and dealers anticipated a decline in U.S. crude oil inventories after last week's big build.

And then the AP gave us Oil falls to near $82 on weak US crude demand—

Oil prices fell from a three-month high above $82 a barrel Wednesday in Asia after a report showed U.S. crude inventories fell less than expected last week, suggesting demand in the U.S. remains sluggish. ... The contract gained $1.21 to settle at $82.55 on Tuesday, the highest since May 4.

If U.S. demand is sluggish, then why is the oil price $82 per barrel? There's lots of spare production capacity worldwide, so that's not the explanation.

The alert reader will notice that the price of crude was $82/barrel in anticipation of a decline in inventories and after inventories fell less than expected. The price was going to be $82/barrel regardless of what happened to inventories. The oil price had nothing to do with inventories

I'm sure you can now figure out (see above) why the oil price has been rising lately. Here's what you need to ask: How is the S & P 500 doing? How is the dollar faring against the Euro? You may regard this post as a free lesson in how to read an oil market report.



What's the upshot of all this? First, the price of crude oil is being set by gamblers investors hedging bets or deciding to put money in risky (or less risky) assets. But what's wrong with that? you might say. Isn't that the way markets are supposed to work? Well, no, not for crucial commodities like oil or food. If gamblers unconnected to the commodity itself want to gamble, they should invest in stocks & bonds or Chinese real estate bubbles. The oil markets, like the financial "industry" itself, remains largely free of meaningful regulation.

And that's why the price of a barrel of oil is meaningless—almost. These finance-types are setting the price of a gallon of gasoline, the very fuel you put into your car's gas tank. If you are among the 18% of Americans who are underemployed, or even if you're not but you're also not wealthy, you care about how much you pay for gas. And truckers care about how much they pay for diesel. And airlines care about how much they pay for jet fuel. And all this price setting is going to affect the macro-economy eventually.

You're being jerked around like a yo-yo on a string.

Corruption & opportunism touches every aspect of American life. That's the real meaning of the oil price.