Oil Drops Below $68 on Waning Consumer Confidence

Oil prices plummeted on the New York Mercantile Exchange Friday to close below $68 a barrel. With diminished activity on the stock market and a report depicting weaker consumer confidence, the price of crude oil slipped more than $3 to a two-week low.

Crude oil on the NYMEX Friday traded $3.01 lower than yesterday, settling at $67.51 a barrel. Intra-day trading saw the price drop as low as $67.12, while the day's high was $71.60.

Trading beyond what the supply and demand fundamentals support, crude oil has found recent strength on economic optimism that the recession is rebounding. Ultimately, negative news today about US retail numbers and consumer confidence effectively dampened oil trading.

The Fed Factor

"If you look at really what happened during the week, this was a market that wanted to rally, and we had so much big economic news this week, but the big factor with was the Federal Reserve statement, which took over the oil trading market for most of the week," said Phil Flynn, vice president in charge of research for PFG Best in Chicago.

After its monthly meeting this week, the US Federal Reserve stated that it would keep interest rates near zero and lessen the rate at which it was buying treasuring bonds. In other words, the Fed is slowing its quantitative easing stimulus to the economy.

"At first, oil traders would say, 'Hey, now that may be bearish, because the Fed is taking away some of the economic stimulus, and that may slow some of the energy demand down the road, or that could slow down the economy, and that could drive prices down.'" Flynn said.

"But because there was so much good economic news leading into that meeting, and because we saw expansion of the economy in both France and Germany, everybody thought, 'Hey, maybe the Fed has fallen behind the curve, maybe the economy is better than the Fed is giving it credit for, and maybe they should be taking away the quantitative easing as opposed to just slowing it down,'" he continued.

This doubt in the actions of the Federal Reserve sparked a momentary rash in commodities trading, boosting the price of oil earlier this week.

Flynn reports that that doubt was erased today with the low consumer confidence numbers, the less-than-stellar US retail numbers and a Consumer Price Index that reported no inflation.

"Then all that concern thinking maybe we'd get into an inflationary cycle because the economy is getting better and the Fed isn't acting enough to rein things in, well now they're saying, 'Hey wait a second. Maybe we were too much ahead of ourselves because this weak economic data shows that maybe the Fed is right on target or maybe not accommodative enough,'" Flynn explained. "I think all this is the shifting of emotions from people thinking that we would see an inflationary cycle to where we are not as inflationary as we were."

Typically, the price of crude oil is inversely related to the value of the US dollar because the commodity is traded in greenbacks. In other words, investors buy oil when there is fear that the dollar will not be able to hold its value.

Beyond Fundamentals

While supply and demand fundamentals underlie the direction of the market, outside indicators, such as positive and negative economic data, have been both bolstering and deflating the price of oil recently.

"In one way, if you look at traditional supply and demand measurements, you'd have to wonder why prices are where they are; but supply and demand are just one element of what goes into the price of crude oil," Flynn explained. "You have to look at the rest of the economic world around us and its impact on the price of crude."

The analyst explained that the price of oil is not just affected by supply and demand, because supply and demand are affected by these outside factors.

"When you consider that the United States government has to print money to keep the economy from going into a depression, that's going to have a major impact on the price of goods -- and we've seen that impact on the price of crude oil," he continued. "You can say all you want to about the supply and demand and price, but you probably would have practically no demand if the Fed didn't do that."

By stimulating the US economy, the Federal Reserve has been able to ward off a stronger recession. While demand has waned for crude oil recently, it could have plummeted had the economy been left to its own devices.

"The Fed basically pumped up the price of crude oil by printing more money, and it was a necessary evil," Flynn said. "In a way, the Fed created crude price inflation. They made the dollar weaker to try to save the economy from collapsing; they've also created more demand."

Natural Gas Slips Even Lower

Continuing its recent decent, the price of natural gas fell for the seventh trading day in a row to settle at $3.238. With extremely bearish fundamentals, the price of natural gas has not been able to sustain a rally for months.

While the US has a record level of storage, both weather-driven and industrial demand have been especially weak this summer for natural gas. Despite this, the analyst reported that the price may have reached its bottom and be on the rise soon.

"On natural gas, we're at the lower end of the $3 range," commented Flynn. "There has been plenty of support down at this range; so I think there's a good chance that the prices could start coming back up."