The reason that several times as much oil is traded as consumed is that only a fraction of the trades carried out are by people and organisations who intend to use or hold the oil. Many more trades take place between organisations and people who are simply trading to make money — as is the case with other commodities, currencies, bonds and equities.

Just as on the stock exchange, whilst many will stand to benefit from a rise in the oil price, some players will take ‘short’ positions where they hope to make money from a fall in price. This is the way that modern markets work, and looked at from a distance it’s why the movement of the market seems to be affected more and more by its direction than by the fundamentals.

The record high oil prices set last summer were followed in the autumn by the most rapid decline in energy prices that the world has ever seen. It has been a rollercoaster ride, exacerbated by the economic crisis of late 2008.

The oil stocks referred to in the press are short-term tank inventories, typically of 90 to 360 day capacity. These are distinct from the discovered but as yet unproduced pools of oil (reserves) which remain buried in the ground for future extraction. Current estimates see over 30 years of oil reserves remaining, but production rates will likely soon fall below world demand. See the first part of Running low on fuel for details.

To answer the first part of your question, there is presently enough production capability to feed the current lowered global demand, with some limited capacity to spare. Nevertheless, the scope for oversupply is not high — and together with recent OPEC production cuts this has placed a floor under the oil price at around $40.

Much of the short-term variation over the past year or so has reflected the effects of speculation. It’s worth bearing in mind that typically around three times as much oil is traded each day as the world consumes, and even this historical multiple may well have been exceeded within recent times.

Thus when prices were rising, traders built long positions, and continued to buy as they bet on this trend continuing. As soon as an identifiable peak was reached, that situation flipped, and traders shorted oil. Some serious anomalies built up as monthly futures contracts expired during the autumn — in the comments stream above I note an occasion when the forward oil price fluctuated by more than $25 on one day alone.

The weekly ebb and flow of economic sentiment often has an impact on the oil price. For example fears about the future of US car manufacturers this spring served to downgrade the market’s view of future oil demand.

One key piece of economic data is the change in oil inventories from month to month. The 26 member states of the International Energy Agency each hold a minimum 90 day strategic reserve, and many have the capability of storing much more — in the case of the US, up to a year’s supply might theoretically be stockpiled if all the tanks were full.

Two different oil prices are widely quoted on world markets — West Texas Intermediate (US Gulf of Mexico) and Brent (UK North Sea). Historically Brent has traded at a $2-3 discount to WTI, reflecting higher transport costs to the centres of demand, but a reversal of that differential in early 2009 told of limited spare storage capacity in the US at that time.

Thus the drawdown or build-up of oil inventories provides evidence of global and national demand in a tangible way that forecasts can not match. Nevertheless, inventory data are prone to later adjustment and are highly seasonal — inventories are built before each Northern Hemisphere winter and gasoline is stockpiled ahead of the US ‘driving season’ in early summer.

All other things being equal (which, of course, they never are) then states would try to build inventories during times of low oil price, and be happy to use those cheaper stocks during price peaks. Anyone who has ever tried to optimise the purchase of a tank of domestic heating oil before the winter will appreciate just how hard it is to get that right. If the price is rising then the temptation is to buy, and if it is falling then you will attempt to wait — forcing the price still higher or depressing it further in each case.

Although a severe world depression would likely have a significant impact on petroleum demand, it’s easy for us (and for the market) to overplay the effects of recession on energy consumption — even within a marked and prolonged downturn like the one we see today.

The US Energy Information Agency compiles an interesting dataset on the US and global petroleum supply balance. In Q4 2008, US petroleum demand was 19.28 mm bbl per day, representing a decline of around 6.3% on a year earlier. In the same period, global petroleum demand fell from 87.00 to 85.74 mm bbl — a decline of just under 1.5%. The effects of the US economic downturn may still be unwinding around the globe, and we may see these numbers converging in 2009 as the US begins to move towards recovery and the world economy continues to slow.

However, even if global petroleum demand falls by 5% from its 2007 peak by this year end, that will merely bring us back to the levels of consumption in 2004. And it’s absolutely critical to recognise that the economic downturn has not in itself created any more petroleum.

The converse is much more likely true — since the collapse in energy prices through late 2008 and the closure of the capital markets since then have resulted in a dramatic reduction in the exploration effort to replace the energy reserves which we persist in using up at a phenomenal rate. And no matter how severe the economic news continues to appear, there still are cars driving up and down the street outside my window as I write.

We’re continuing to deplete the finite energy reserves we have available to us, and so in the longer term upward pressure on oil prices must resume.

I hope that helps to answer your questions, and thanks again for asking.

In your estimation, is there enough production capability to feed the current lowered demand for oil worldwide in this recession?

I read how stocks of oil – in the US for example -have built up, which lowers the price, but I have no idea how long those stocks would last in a not-so-dramatic upturn in world economies.

Do you know how long those oil stocks would last – Are we talking in terms of days, weeks, or months?

Is this the bottom of the cycle, or just a dead-cat bounce? The analysts see no rise in sight. Which often means…