The lastest oil advance was what I call a “melt-up.”

There were three news stories, although all are quite well understood. Dollar weakness, the unexpectedly large US unemployment report, and the Iranian “story” from Israel all conspired to trigger the upward move. So far, so good. But it’s the same news as we’ve seen many times before. Nothing new, really. (139th story about the impending attack on Iran, for example… Yeah, right. I’ll believe it when I hear the bombs explode.)

But then came the short-covering that drove what would have been a $2 or $3 move into an almost $11 move. Hence the melt-up.

The normal reaction to the excessive advance is a retreat… and this is what we’ve seen early week — when retreated about $3/bbl.

By definition, the “futures” markets are all about the future.

In general, in the future people expect to see a weaker dollar and tighter supplies of oil that cannot meet projected demand.

The way to break this cycle is with a clear signal from the US Federal Reserve that it will defend the dollar. I’d like to see a 1% interest rate increase, with language that if this does not get the dollar on track then there will be more rate increases. This will hurt some parts of the economy (like housing). But it will salvage the rest of the economy. As things now stand, high energy prices are just going to kill off the bulk of the economy and destroy the American middle class.

But this monetary action is only half of the solution.

The other half is that the US govt needs to adopt a strong, production-oriented energy policy. Yes, the new policy must include the usual tributes to conservation & efficiency… as if high energy prices do not enforce and drive home the import of such virtuous behaviors. And the new policy should give wide leeway to windmills, solar, geothermal and 2nd generation biofuels. It’s a true shame to waste good coal or oil on something that you can do with a windmill. But you cannot run an economy on windmills, solar, geothermal and biofuels alone.

U.S. Dependence on Oil…

The US needs to focus on North American energy production, via oil & gas drilling in Alaska and offshore, plus “clean coal” technology, coal-to-liquid, oil shale development, gas hydrates, next-generation nuclear, and anything else that will work in the next 10-20 year time frame.

Just the announcement that the US is adopting this pro-production policy will shape the marketplace and tend to drive long-term prices down. The worst case is that it will sure moderate any future price increases.

There is an astonishing amount of energy technology out there, already invented and workable. The great challenge of the future is systems integration, to bring it all together and apply it to our problems. Integrate it, make it work and scale it up. This just takes a lot of hard work, with direction and incentive to achieve.

The first energy “system” that is broken in the US is the lack of coherent, national energy policy. We have to fix that.

And if we don’t defend the dollar, what’s the use? The dollar will die, and we’ll be calculating our energy transactions with seashells or pretty stones.

Best,

Byron King

Note: Byron King is a frequent contributor to the free e-letter Whiskey & Gunpowder. To receive daily insights into energy, oil, commodities and other natural resources sign up here!

Source: The Oil ‘Melt-Up’ and Why the U.S. Economy Won’t Run On Windmills Alone.