NYMEX Crude Oil Futures this week reached back above the $70-per-barrel mark, part of a dramatic climb back from the $40-per-barrel range.  The rise in oil prices is expected to ease the budget strain that oil-exporting countries have experienced in the wake of unprecedented low oil prices.

However, while there are guesses about what is causing the rise in oil prices, the actual mechanics of the situation are cloudy.  Suggestions have included the following:

• The idea that recent production cuts by OPEC are finally beginning to take effect.
• Consumption is beginning to recover from the recession.
• Inflation is occurring due to high levels of borrowing and spending in the United States, resulting in a devaluation of the U.S. dollar relative to other currencies.
• “Speculators” are returning to the oil market, giving us another taste of the volatility of last summer.

All of these things could be drivers of the current increase. Nevertheless, the following are also true:

• Despite recent production cuts and cuts in planned capacity expansion, inventories appear to remain high with high levels of supply.
• Consumption does appear to be recovering, albeit more slowly that it fell.
• Inflation still has not caught up with recent government spending. According to InflationData.com, the consumer price index actually turned negative in March and went even further into negative territory in April.
• With high levels of physical inventories and idle capacity, it is unlikely that speculation can go far, although speculation can serve to amplify other trends.

It may be that shifting fundamentals —severe cuts in planned capacity expansions and production and signs of economic recovery —coupled with fears of impending inflation have drawn speculative money back into the commodities markets. This influence was recently noted by the OPEC secretary-general as quoted in the Financial Times: “Speculators are coming back, not only to oil, but to all commodities. We are not happy … and we do not want to see them to be a factor in prices.”  However, the underlying market fundamentals will have to shift to allow them to stay in the market over the long term.

It’s hard to predict which direction oil prices will go from here, but up or down I expect oil prices to remain volatile in the next few months.

   Energy prices from Bloomberg

   CPI data from Inflation Data