By Jason Simpkins
Crude oil for December delivery rose to a record $96.24 a barrel on the New York Mercantile Exchange yesterday (Thursday), making it a near-certainty that crude prices will smash through the psychologically important $100 a barrel level even sooner than analysts had feared.
In a related story yesterday, oil industry bellwether Exxon Mobil Corp. (XOM) reported third-quarter profits of $9.4 billion - a 10% decline from the year before, and an earnings disappointment that caused U.S. stock prices to swoon.
The Dow Jones Industrial Average plunged 362.14 points, or 2.60%, to close at 13,567.87. The broader Standard & Poor's 500 Index dropped 40.94 points, or 2.64%, to finish the day at 1508.44. The tech-focused Nasdaq Composite Index closed at 2,794.83, a decline of 64.29, or 2.25%.
Analysts said the spike in oil prices, a surprise earnings decline from Exxon and a worrisome analyst's report about finance giant Citigroup Inc. (C) combined to spawn the sell-off. [To see Money Morning's related news story about Citigroup, please click here].
Oil prices continue to be a major concern to the financial markets.
Oil Prices Spike
While energy investors continue to reap windfall profits, neither oil producers nor U.S. consumers are happy about the steep escalation in petroleum prices.
Consumers fear the high price of oil could spur inflation or worse, ignite a U.S. recession. Meanwhile, many global oil producers worry that oil's price tag will encourage its throngs of customers to seek shelter in alternative fuels.
Oil's price surge seems unstoppable at this point. Prices have spiked more than 30% in the last month - and quadrupled since 2002. The surge has been supported from almost every conceivable angle. An emaciated dollar, political instability in the Middle East, Federal rate cuts, and low inventories have all contributed to oil's spectacular rise. And now the price is going to be paid at a considerable expense to the global economy.
This week was a particularly harsh weak as the Fed issued its second rate cut in as many months, further devaluing the dollar. Then, the U.S. Energy Administration said that commercial crude inventories fell by 3.9 million barrels in the week ending Oct. 26. At 312.7 million barrels reserves, are at their lowest point in two years.
Raging Oil Prices Back Markets Into a Corner
"The whole game has changed," John Silvia chief economist of Wachovia told CNNMoney. "If [oil prices] are sustained here, going into the holiday season, you're going to have a pretty horrendous fourth quarter."
David Wyss, chief economist with Standard & Poor's, agreed but he thinks oil will have to gain a few more dollars before it drags the nation into a recession.
"My guess is we have to go over $100 to get to a recession. How much over $100, I'm not sure," Wyss said.
Emerging nations are feeling the pressure too, particularly China. China's blistering economy, which expanded by 11.9% in the second quarter of the year and 11.5% in the third, is already battling excess liquidity that has saturated the market. Its government recently announced an inflationary rate of 6.2% in September, down only marginally from a 10-year high of 6.5% in August.
Also, China's central bank chief Zhou Xiaochuan blames an influx of OPEC dollars for exasperating the problem.
"The high oil price has resulted in a surge of cash at oil-producing countries, and as a result, this large amount of funds is flowing around the world looking for investment opportunities. China's excess liquidity is partly linked to a surge of cash in the world, which is partly contributed by oil producing countries," he told Bloomberg.
What Zhou may not realize is that OPEC agrees that prices are too high, it just doesn't feel it's in any position to do anything about it.
OPEC Struggles to Preserve Pricing Balance
Soaring prices have also given the OPEC something to think about as well. The cartel has repeatedly asserted that increasing production would have little impact on the price of oil, which it says is the product of financial speculation, geopolitical instability and a shortfall in refining capacity.
The Qatari Energy Minister, Abdullah bin Hamad al-Attiyah, described the futility of pumping more oil into the market to bring down prices to the International Herald Tribune.
"To increase by 500,000 or one million barrels, do you believe today it will bring back the price? I don't think so." Attiyah said, emphasizing his view that the price of oil had become almost wholly decoupled from supplies.
"Please don't blame us - you blame us for the last 50 years," Attiyah pleaded.
The president of OPEC, Mohammed bin Dhaen al-Hamli, who is also the oil minister of the United Arab Emirates, pledged to keep markets amply supplied.
"Increasingly, oil markets are being driven by forces beyond OPEC's control, such as geopolitical events and the growing influence of financial investors," the paper quotes him as saying. "We are of course concerned about the high level of oil prices."
OPEC is concerned that oil at such exorbitant prices will encourage its customers to pursue alternative sources of fuel. Galo Chiriboga, Ecuador's oil minister told the Financial Times that OPEC's main challenge over the next five to 10 years is preserving "a price equilibrium that keeps crude oil positioned favorably against other alternative energy sources."
"It's better to have 50% of something than 100% of nothing," he said.
Alternative energy sources have gained more credibility and more attention in recent years as the world has become increasingly wary of carbon dioxide emissions. Nuclear power has renounced much of its "Three Mile Island" stigma and has once again become a viable alternative to power plants fueled by coal and oil. And experimentations with several different kinds of biofuel and the introduction of hybrid cars are beginning to work their way into the mainstream.
"When [oil prices] get this high, it becomes uncertain and everyone gets scared," Mitsubishi's Anthony Nunan told Bloomberg, "Since $100 a barrel is a reality, $125 or $130 is also possible."
According to Bloomberg, 49,744 call options contracts have been taken out to buy December crude at $100 a barrel. Traders reportedly held 2,526 options contracts each granting the right to buy 1,000 barrels of December oil at $125 in New York, as of October 29.
In the final quarter of 2005, Exxon recorded the largest quarterly corporate profit in world history: $10.7 billion. Unfortunately for investors, this year's third quarter wasn't an encore performance.
For the three months ended Sept. 30, the Irving, Tex.-based Exxon said earnings dropped to $9.41 billion, or $1.70 a share, from $10.49 billion, or $1.77 a share, in the year-ago third quarter. It was the worst decline since the first quarter of 2004 as the world's largest company came up short of analyst estimates. Wall Street had expected a profit of $1.75 a share, according to a survey of analyst estimates published by market-researcher Thomson Financial.
Exxon reported third-quarter revenue of $102.3 billion, an increase of about 3% from the comparable quarter last year.
In a research note to clients, Lehman Brothers Holdings (LEH) analyst Paul Cheng said Exxon reported lower-than-expected volumes of both oil and gas production - as well as lower-than-expected earnings. Since Exxon doesn't break out so-called "one-timers" - including asset sales, currency issues and inventory problems - Cheng said it was impossible to tell if any of these items led to the lower profits.
Even so, Exxon exceeded his own estimate of $1.67 a share with earnings of $1.70 a share, chiefly because of better-than-projected international refining and marketing results, Cheng told clients.
Robbert Van Batenburg of Louis Capital Markets told CNNMoney.com that Exxon boosted its capital spending by 7.5% to $5.4 billion.
"Exxon [is aggressively] trying to boost production, which declined in third quarter, through mainly offshore," Van Batenburg said.
During the quarter, the company repurchased 90 million shares of its own stock for about $7.8 billion.
Shares of Exxon hit an all-time high of $95.27 on Oct. 17 and have fallen back to the low $90s since then. The company's shares closed yesterday at $88.50, down $3.49 each, or 3.79%.
Crude oil prices soared from about $71 a barrel at the start of the quarter to more than $81 a barrel by the end. Since the end of September, crude futures have risen to more than $90 a barrel up from the $80 mark. Many industry experts - as well as experts here at Money Morning - expect crude oil to fetch more than $100 a barrel in short order, helped as the greenback continues to fall against other currencies.
J.P. Morgan Chase & Col (JPM) analyst Michael LaMotte last week tapped Exxon as his top pick, along with Occidental Petroleum Corp. (OXY), due to "lower resource conversion costs and higher returns on new projects."
News and Related Story Links:
Oil Hits New Record High, Breaking $94 a Barrel.
Exxon Mobil: $9.4B Profit in 3 Months.
Soaring Oil Prices Spell Trouble For Emerging Markets
Record Oil Prices Continue to Push Canada's Dollar, Inflation.
- Money Morning:
Soaring Oil Prices, Debt Concerns Send Stocks Skidding Yesterday; Oil Spikes in Asia Today.
Oil Traders Increase Bets on $125 Crude as Options Trades Jump
Weaker economy could be tipped into recession by $90 oil - Oct. 30, 2007.
- CNNMoney.com: .