Oil Price Lower on Inventory Numbers, But It Can't Go Much Lower

Includes: DBO, OIH, OIL, USO, XLE
by: Robert Weinstein

Yesterday's release of the US inventory numbers of oil and oil related products had a quick and meaningful impact on prices.

With the news machines pumping full speed ahead to tell us how bad the economy is doing, it's no wonder why we have seen a crash in prices.

We have seen $10 oil in the 90s and sub $20 oil as recently as 2002. Can we see those prices again? Let's take a look at the fundamentals.

For sure we could see a further drop in oil prices, but to what point? Could we once again see $10 oil? Not likely, even with the fantasy idea that the so-called evil speculators are and will continue to be driving the price of oil down.

Even with a drastic drop in the price, it would be short lived unless some game changing technology displaces oil as the leading source of gas and diesel. Short of a game changer, it's hard to picture a world that will see sub $20 oil again.

On the demand side we have several major changes since the last time oil was at $20 per barrel. The US, China, and India all use more oil than they did 10 years ago. I guess the Europeans like riding the bus and train as their increase in consumption is much lower. Regardless of what Europe is doing, the fact remains that in most parts of the world, oil consumption is going higher. I would like to note that Brazil has done a fine job of changing from a net importer of oil to a net exporter. A fine example for others to follow.

On the other side of the coin you have the supply side. While many will tout the peak oil theory, I do not feel we are there yet. New fields are being found and some of the largest oil fields have hardly been tapped. Canada and the US have very large oil shale deposits available, but the cost to extract this oil is much higher than in most of the other fields in the world. This of course is a floor creating mechanism for oil. We have oil but just not at the $20 per barrel price we would like.

One more factor is that much of the world's supply of oil comes from volatile places. Taking a quick look at Nigeria, Iran, and Iraq leaves no doubt that the daily supply of oil is in a constant state of risk. Short of news that algae can be made into diesel for $1 per gallon, I can think of no other major news that would be extreme and bearish for the price of oil.

As a result, I find it very comfortable to be writing out of the money puts against USO ( an oil fund ETF) for February, March, and April.

Disclosure: I am short USO puts