Why Oil Prices Aren't Falling

By Daniel Kadlec.

Traders blamed the bitter dispute at Russian oil giant Yukos for propelling crude prices to record levels last week. But what's less clear is how a company that produces just 2% of the earth's oil supply can trigger a worldwide hike in the price of September crude, which reached $44.60 a barrel on Friday.

The answer lies as much in psychology as in economics. "There's not a lot of logic to the move that oil has had," says Jeff Kleintop, chief investment strategist at PNC Advisors, noting that a tepid U.S. jobs report last Friday raises the specter of a decelerating economy, which would cut demand for oil. Indeed, share prices of U.S. refiners like Sunoco and ConocoPhillips tumbled even further than the overall market did last week.

But the Yukos political melodrama is hard to ignore. The Russian government is seeking to collect $6.8 billion in back taxes from Yukosan effort that has threatened to send the company into bankruptcy. That prospect is highly unlikely, but the mere possibility has spooked traders. That tiny share of the world's oil could loom large if it were disrupted even temporarily, which would surely push prices higher. Nor does the Kremlin appear to have any qualms about roiling the world's oil markets as the battle with Yukos drags on. "The people who are masterminding the assault on Yukos simply do not take such economic factors into account," says Alexei Kondaurov, a former top Yukos executive. A Moscow court last Friday overruled the Kremlin's seizure of Yukos' core production unit. The government's strategy is to "play a cat-and-mouse game with the company" to drive down its market value and hope to buy its oil assets on the cheap, asserts Mikhail Krutikhin, an analyst at consultant RusEnergy. Oil users across the globe are trapped in the game too.

--By Daniel Kadlec. With reporting by Yuri Zarakhovich

With reporting by Yuri Zarakhovich