Crude prices increased for the second day in a row, closing above $71 on the New York Mercantile Exchange on Thursday.
Crude oil gained 34 cents on the NYMEX in trading Thursday, settling at $71.37 for July delivery. Crude settled at $71.91 for August delivery, and London's Brent crude was up 21 cents Thursday to $71.06 on the ICE Futures.
Energy expert, David Pursell of Tudor Pickering Holt & Co., an energy investment firm based in Houston, cautioned that the fundamentals are not supporting the current high price per barrel.
"It's hard to justify $71 oil based on the underlying oil fundamentals," said Pursell, who serves as the managing director and head of macro research for the firm.
With record inventories and soft demand, the OPEC cuts in production do not support the current price of oil, he explained.
"I think it's an inflation trade," Pursell said. "It's much like last year. Last year, you could have said early in the year that $110 oil is too expensive; and guess what you were right, but you were also spectacularly wrong, as oil went to $145. Oil is too expensive, but that doesn't mean that it can’t keep going up."
He believes that the market is buying hard assets, including oil, as a hedge against inflation.
"Everybody knows we're printing a lot of money, and there's a sense that at some point that inflation is going to kick in," he continued. "And although there's not a guarantee, there's a high enough likelihood that people are making this kind of inflation hedge."
Pursell also expressed concern about changing fundamentals when oil prices climb above $70. With prices so high, he questioned whether OPEC compliance might break down.
"I worry about demand," Pursell continued. "We know that when oil got above $90 last year, and $90 barrel oil means $3 gasoline here in the States. When gasoline got to $3, demand was impacted. So the concern you have is in an economy that’s weaker, there should be a lower price threshold where demand is impacted."
In addition to changing OPEC production and weakening demand for oil, the expert foresees an increase in non-OPEC supply.
"I'm also forecasting non-OPEC supply decline in 2010 because of the lower oil prices," he continued. "But if oil is at $70, I may not see the kind of declines next year in oil supply that I'm forecasting, because people are going to keep drilling for oil because you can make money."
These three factors may affect oil prices at the current price point, Pursell concluded.
"So all three factors that were really good from a fundamental standpoint, OPEC compliance, low prices maybe helping demand a little bit, and non-OPEC supply falling, those all three go the other way with $70 crude," he admitted.
Natural gas reversed yesterday’s increase, falling 16 cents to settle at $4.093 for July delivery. Prices for natural gas settled at $4.278 for August delivery.
"Gas is easy," Pursell said. "Three words: too much gas."
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