Why Wont Oil Wont Climb To Pre-May 5 Levels Any Time Soon?

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Because no one could explain why they were that high in the first place.

Lucien Zeigler | 5/7/11

Friday’s report that the US economy added 244,000 jobs in April is very encouraging. Bad economic data for the United States was part of the reason for the great sell-off that happened Thursday, according to reports in the Wall Street JournalFinancial Times, and Bloomberg that emerged last night.

If the report on US jobs had been bad on Friday, it could have sent markets and traders “toward the lifeboats,” wrote Robin Harding in the Financial Times. But “instead, it was a solid jobs report.”

So, logically, the question is: following an encouraging report that signals the recovery in the US is not as bad as previously thought, will commodity prices, oil especially, rise back to pre-May 5 numbers?

Answering that question requires understanding why, in tangible reasons, oil climbed that high in the first place. Analysts had more reasons than usual for something that should be simply explained: Middle East unrest (especially in Libya), China’s surging demand, and the occasional encouraging economic data in the United States. However, none of those explanations, taken individually or coupled together, should have driven oil prices to levels not seen since 2008.

This led to inventory saturation, which ultimately contributed to the so-called “Flash Crash” that the markets experienced yesterday.

Without a really good explanation as to why oil was so high prior to May 5, it’s hard to predict if it will ever return to those figures. If we accept that most of the reason for the price surge was uncertainty over Middle East unrest, then it is worthwhile to evaluate what is going on in the region with respect to production stability.

First and foremost, the situation in Libya is still unresolved, but if it can be qualified in this way, it is “less unresolved” than it was a few weeks ago. By no means do we have a resolution to the conflict, or are even close. However, our uncertainty about the situation has been reduced. NATO/US involvement, some gains by the rebels, but most importantly, the purchase and export of Libyan crude sold by the rebels (and brokered by Qatar) should give markets some semblance of calm that Libyan production of crude will, eventually if slowly, resume. We know at least that the rag-tag Transitional National Council rebel government in Benghazi is still thrilled about international involvement to tip the scales in their favor, but also that they are willing to sell oil to the West now and when they ultimately take over in Tripoli.

And then there was the “biggest question mark” of the oil price run-up of 2011: whether or not the instability in the Middle East would rock the world’s largest oil producer in Saudi Arabia. In the run up to the so-called “Day of Rage” planned protests, traders and speculators were afraid of civil unrest in the Kingdom, and showed that they were merely fearful, not informed, about the political situation in Saudi Arabia. Some Saudis did take to the street that day – to praise the enormously popular King Abdullah.

The people who took to the streets in Saudi Arabia were rewarded, ironically enough, by the same fear-driven speculators in New York and London who believed instability would rock Saudi Arabia like it did other Middle East countries. Once the “Day of Rage” fizzled, King Abdullah soon thereafter rewarded Saudi citizens with a massive economic stimulus package that will address many of Saudi Arabia’s most important underlying economic concerns, mostly housing, education and cash. This so-called “Saudi Stimulus,” which some experts put at nearly 20% of the Kingdom’s GDP, will be funded in part by revenues from oil’s surging price.

As John Sfakianakis, chief economist at the Banque Saudi Fransi told Bloomberg shortly after the package was announced, the Saudi Stimulus “has, really, a social welfare purpose to it.”

All of this is to say that, however unlikely Saudi instability may have been before the so-called “Day of Rage” turned into a “tempest in a teacup,” as Saudi Prince Alwaleed Bin Talal called it, instability in the world’s largest oil producer is exceedingly unlikely to happen now.

Oil speculators are a little red faced following yesterday’s commodities tumble. An encouraging US jobs report that emerged this morning signaled that the US economy wasn’t that bad after all. So why didn’t we see the price jump back to pre-May 5 numbers on Friday?

Because no one could logically explain why they were that high in the first place, and now that the situation in the Middle East is more certain (though still unresolved), it’s unclear whether we’ll touch those outrageously high prices anytime soon.