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What's Going On in the Oil Market?

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So -- what's behind oil's latest price spike? And the general price spike that's been happening for the last year and a half? There are a ton of contributing reasons, but one stands out as the biggie.

First -- let's look at a few price charts.

The is a weekly chart of oil which goes back about three years. Notice the following points on this chart:

-- The market has been in a strong rally since the beginning of 2007.

-- Prices have continually moved through previously established resistance points.

-- Prices have consolidated price gains in 4 different areas.

-- Notice that all the simple moving averages (SMAs) are moving higher.

-- The shorter SMAs are above the longer SMAs

-- Prices are above all the SMAs

This is what a bull market chart looks like.

Let's go to oil's daily chart.

-- The market has been in a strong rally for four months.

-- Prices have continually moved through previously established resistance points.

-- Prices have consolidated price gains in 3 different areas.

-- Notice that all the simple moving averages (SMAs) are moving higher.

-- The shorter SMAs are above the longer SMAs

-- Prices are above all the SMAs

This is what a bull market chart looks like.

Oil is priced in dollars. Let's see what the dollar chart looks like.

On the weekly chart, notice the following points:

-- Prices have moved lower for the last two years

-- Prices have continually moved through support to hig lower levels

-- The 20 and 20 week SMA are both moving lower; the 10 is moving horizontally for now

-- Prices are below the 20 and 50 day SMA and are trading right with the 10 day SMA. This is a very bearish configuration.

On the dollar's daily chart, notice the following:

The dollar dropped at the end of February, eventually consolidating in a triangle pattern from the end of March to the end of April. Prices have risen a bit since then, but are now trading between 72 and 73.5. Prices and the SMAs are bunched together with the SMAs all moving sideways indicating a lack of direction.

So -- the unit of currency used to price oil has been dropping hard for the last two years. In addition, on Thursday, the European Central Bank's President made very hawkish comments:

European Central Bank President Jean-Claude Trichet said Thursday that inflationary pressures in the euro zone will last longer than previously expected, with risks to price stability increasing further in the wake of robust food and oil prices.

The ECB may even raise its 4.0% interest rate, left unchanged on Thursday, at its July meeting, Trichet said. "I don't say it's certain, I say it's possible," he said.

Inflation trends have put the ECB in a state of "heightened alertness," Trichet said after the Governing Council meeting in Frankfurt.


His more hawkish slant was further underscored by the bank's new staff projections for economic growth and inflation over the next two years. Inflation in 2009 is seen at around 2.4%, Trichet said.

Any projection for inflation in 2009 above 2.3% is "an unexpectedly hawkish signal," said Holger Schmieding, an economist for Bank of America.

"A number of us (on the Governing Council) "thought there was the case for raising rates," but Thursday's decision was taken by consensus, Trichet told reporters.

Higher European interest rates make the euro more valuable and the dollar less valuable by comparison. As a result, the euro has been rallying for two days and the dollar has been dropping for two days adding to more concern about the currency the oil is priced in. Hence, we get more increases in oil's price.

There has been some speculation that hedge funds are responsible for these price spikes. While they are responsible for some of the spike, they are not the primary cause. Right now people are looking for a scapegoat to blame, hoping that getting rid of the scapegoat will get rid of the problem. The real problem is two fold.

1.) China and India are growing. This is raising the standard of living of about 2 billion people, thusly increasing oil demand worldwide.

2.) At least from the US perspective, it should be clear that we have no energy policy and that our current "policy" (using a very liberal definition of that word) encourages massive consumption. Barry Ritholtz over at the Big Picture Blog wrote this list of 27 things the US has done which are adding to oil's price increase:

1. Limited areas available for offshore drilling;

2. Stopped the rise of CAFE standards for automobiles;

3. Restricted nuclear power generation of Electrical;

4. Federal Reserve policies since 2001 led to a very weak US dollar (raising Oil prices);

5. Energy conservation policies? None

6. Iraq and Afghanistan wars contributing to Middle East tensions

7. No major United States funding for R&D on energy;

8. Kept CAFE standards for light trucks/SUVs much lower than autos;

9. Failed to raise efficiency standards for appliances for decades;

10. Provided no tax incentives for consumer purchases of hybrid automobiles for decades (in 2005, provided a modest, now expired tax credit);

11. Suburban Sprawl: Americans, on average, live further from where they work than Europeans do;

12. Mass transit system not a high priority;

13. Allowed tax credits for residential solar power to expire;

14. No special capital gains treatment for VC investment

15. Ridiculous corn ethanol policy helped drive food prices higher also;

16. Amongst the lowest gasoline taxes in the developed world;

17. No special capital gains tax treatment for clean energy technology development;

18. Created a tax incentive (ADCS) that encouraged purchases of large inefficient vehicles;

19. Game changing breakthroughs over the past decades in solar, battery, or energy generation technologies? None

20. Exempted light trucks, SUVs, and pickups from gas-guzzler tax;

21. Discouraged clean coal, including gas liquification from coal;

22. Limited (or non-existent) state tax incentives for building energy efficient homes;

23. Failed to aggressively promote compact fluorescent light bulb;

24. Limited hydro-electric power generation;

25. Aggressive tax incentives for battery technology development? None

26. Failed to aggressively promote efficiency improvements for residential energy use, transmission of power, or consumption;

27. No new oil refineries built in the USA over the past 25 years.

I realize some people may disagree with some of the above points, but there is no doubting all the above points are helping to push up oil's price.

The bottom line is this: the reasons for oil's upward spike run deep and wide. The main contributing factor -- the dollar's drop -- isn't going away anytime soon, largely because the US' federal finances are a total wreck. It's going to take a massive effort by Washington to develop and implement a national energy policy -- which this country desperately needs. Given the current environment in Washington I'm not holding my breath.