WTI Apr13.pngHave you ever wondered, as you pay your energy bill or fill the fuel tank in your vehicle, just why oil prices have risen so much on the past decade? The question occurred to the blog when reading a Reuters report of the latest Outlook from the International Energy Agency (IEA). It notes the IEA has further reduced its demand forecast and is now warning:

“Demand has been exceptionally weak in the OECD, notably in Europe, where consumption in 2013 is expected to be the lowest since the 1980s”

The Reuters report then adds that “Surplus oil is filling inventories worldwide and U.S. stocks are now higher than at any point since 1990”

The chart above shows the position over the past decade in the US market, based on official US Energy Information Administration data:

• Since 2003, inventories* (red line) have risen steadily from 45 to 60 days of demand
• Prices (blue column) have gone in the same direction, rising from $31/bbl to $94/bbl
• Thus inventories have risen by a third, whilst prices have trebled

This outcome demonstrates conclusively that oil markets no longer fulfil their price discovery role. In particular, there has been no fundamental reason to justify the renewed price surge since 2009. Yet as Citi oil analyst Ed Morse noted last month:

“The broad consensus in the oil industry and the analytic community is that oil demand will continue its inexorable rise through to 2030. This consensus in turn underpins the belief that oil prices will have to stay high versus historical norms”.

This is yet further evidence for the blog’s long-standing argument that the $tns of liquidity provided by the major central banks have completely distorted normal price signals. Oil prices are instead being set by speculative purchases from pension funds seeking to find a ‘store of value’, and by hedge funds enjoying a momentum play.

Reality always breaks through in the end. And when it does, it is likely to prove extremely painful for all those of us living in the real world, who are the innocent victims of the central banks’ folly.

UPDATE: The IMF warned Wednesday that pension fund investment in commodities and similar assets was “a gamble that could harm not only pensioners and insurance customers, but also the financial system” It suggested some funds have 25% of their funds in such “risky investments”.

* The chart shows demand in terms of total oil and product inventory, excluding the Strategic Petroleum Reserve