Skyrocketing oil prices made front-page news this week, hitting $66 per barrel August 11 before closing at $65.8/ bbl. Natural gas prices received less attention but increased another 10 percent in the last week alone. September gas contracts closed yesterday at $9.30/MMBtu, and the future 12-month average now stands at $9.36/MMBtu. What does the persistent run-up in oil and gas prices tell us? The media recite a hodgepodge of excuses for high oil prices. Those include refinery problems, weather, diplomatic dustups in Iran, and so on—none of which is relevant. The real reason for rising oil prices is that Saudi Arabia hasn't been able to come up with the additional oil it has promised. The markets confronted the Saudis, challenging them to put more oil in the market. Production in the former Soviet Union may increase somewhat this year, but it is approaching its limits and cannot keep up with growing consumption. Officials in the U.S. and Europe have taken the Saudis at their word, counting on them to keep increasing production for the next two decades. Other experts, notably energy investment banker Matthew Simmons, say the Saudis don't have the resources. It is impossible to know whether the long-term Saudi outlook is as bleak as Simmons projects. In the meantime, however, I expect oil prices to continue upward until additional oil shows up, or until prices get high enough to choke off consumption. Goldman Sachs projected earlier this year that it would take a price of over $100/bbl to bring supply and demand into balance. The North American gas situation is quite similar to that of global oil—North American sources of supply have reached their limits, and prices will remain strong until substantial additional supplies are imported in the form of liquefied natural gas or until consumption falls. The difference is that sources of LNG do exist, while Middle Eastern oil is about tapped out. The gas markets are displaying a bit of irrational exuberance, since there is plenty of gas in storage for the coming months. But additions to storage have been below expectations for the last two weeks, and the oil situation provides plenty of additional support for the bulls. The White House gang faces quite a dilemma. On the one hand, they and their oil-patch buddies are delighted with high oil prices. But on the other hand, if oil prices continue to rise, the current administration could well be swept out of office in the next election, especially since the energy legislation signed this week is widely seen as unresponsive to consumers' problems.
