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Oil Prices Ignore Supply, Demand Picture: Here's Why

Wednesday, 6 May 2009 | 3:46 PM ET

Why is oil trading near a 6-month high—breaking into a new range—and rallying above $56 a barrel, when oil supplies are at the highest level we've seen since 1990 and demand is tanking?

Oil remains technically strong today, despite rather bearish fundamentals, as traders continue to follow the equities market. Crude's broken into a new range and a settlement above $55 is significant.

What's fueling the momentum? Nymex traders tell me they're seeing new money coming in from passive funds that are reallocating assets away from precious metals and into energy holdings. It's this money flow—rather than the fundamental supply/demand data—that's driving oil prices higher.

Oil Tomorrow
CNBC's Sharon Epperson discusses the day's activity in the commodities markets, including the oil inventory numbers, and looks ahead to what's likely to happen tomorrow.

Video: CNBC's Sharon Epperson discusses the oil build and why prices continue to climb.

Looking at the intraday chart, though, it's clear that today's rally started with the job loss numbers from ADP (not as bad as expected) and continued when the Energy Department showed oil supplies rose less than expected and gasoline supplies declined slightly. Traders read that as neutral, not bearish—perhaps even as somewhat bullish. The fact that refinery run rates ticked up nearly 3 percentage points to 85 percent capacity has added to some traders' optimism that this market is turning around.

Still, the overall supply/demand picture remains extremely bearish. U.S. oil supplies are at an 18-year high, and demand is at its lowest level since September 2001, at an almost 8 percent decline from a year ago. Product demand posted double-digit declines in every category over the past four weeks, except for gasoline, which fell about 0.4 percent.

Yet, if stocks hold up in the face of bank stress test results tomorrow and April unemployment data on Friday, oil prices may make a run to $60 a barrel. And with money that was sitting on the sidelines coming in, investors will likely help propel the run up—buying more oil (and natural gas—notice today's 7 percent surge) just to have a little skin in the game.

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