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Oil Prices Are Not Going to Spike Again Just Yet

The party isn't over -- at least not yet.

For the last year, relatively low oil prices have helped us all cope with the economic collapse. We've paid less for gasoline than we have for years. And businesses have paid less for running their factories, planes and product transportation.

But last week we began hearing the music die down and waiters moving guests out the door. The trigger was crude oil surging through the $80-a-barrel barrier for the first time since September 2008. Goldman Sachs, among others, said the hike is a signal of even higher prices going forward. Goldman predicts an average of $110-a-barrel oil next year.

Here's one big reason why the bulls so predict: Global oil exploration and production have dropped, and when economies rebound there will be a shortage. Hence prices are bound to rise. In the U.S., for instance, exploration is down 27.8% from a year ago, with 309 rigs actively drilling, compared with 428 at this time in 2008, according to the Baker Hughes Rig Count. Abroad, there are 8% fewer rigs drilling than there were a year ago—764, down from 831.

Of course, at some point these fellows will be correct -- global economics will gradually improve, and oil and gasoline prices will rise. But as numerous other analysts tell me, there are numerous reasons to expect oil prices to stay where they are, or even drop, for the next year or two.

When oil prices rocketed past $140 last year, the cause lay mostly with speculative dollars capitalizing on the supply-demand balance: There was virtually no spare production capacity anywhere in the world, so that any supply disruption, such as hurricanes in the Gulf of Mexico and the routine militant attacks in Nigeria, pushed prices up. Taking advantage of the tight market, a wide swath of investors including university endowments, investment funds and small investors piled in to funds holding oil futures, driving the price up.

But the situation is different now. Saudi Arabia has added a huge volume of fresh production capacity since last year. Globally, oil producers can produce 6.7 million more barrels a day than they actually sell, according to the International Energy Agency; Saudi Arabia accounts for 3.8 million barrels, or 56%, of the total.

And why aren't the Saudis and others running their oil rigs at full-capacity? Because there's a huge volume of crude already sloshing around the world. New U.S. government data shows that the U.S. stockpile of oil rose by 800,000 barrels in the latest week, and stored gasoline by 1.6 million barrels. All in all, U.S. crude inventories stand at around 340 million barrels, up 27% from a year ago, reports the U.S. Energy Information Administration. In addition, since mid-September the Strategic Petroleum Reserve has exceeded 725 million barrels, a 27-year record. Together, that's about 118 days of U.S. oil imports.

In fact, there's such a global glut that there's almost no place on land to put all the oil. An estimated 125 million barrels' worth are floating around on tankers scattered over the globe, according to the Organization for Petroleum Exporting Countries. Normally, a negligible amount of oil is being stored offshore in ships.

Much of that oil would have to be drawn down before any big price spike takes place.

The main driver of last week's price runup was the weak dollar -- since March, the dollar has fallen 15% in inflation-adjusted value compared with a basket of currencies of its major trading partners. Traders have sought to cushion the fall in the value of the dollars they are holding by buying futures in traditional safe havens. While oil prices have surged by 71% since March, gold has also soared this year by more than 20%, to more than $1,000 an ounce.

But for the last few days, the dollar has hardened up. And oil prices are back down. Today, they fell to $77.46 a barrel.

Maestro, more music please.

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