Oil’s Running - How Strong Are Its Legs?

This week (June 8-12) I was interviewed by several media sources regarding my thoughts on oil and the direction of gas prices at the pump. These are a few of the questions I was asked and how I responded.

Question: What happened in the last month that prompted this increase in gas price -- and oil price for that matter?

Response: Over the past month oil prices have moved forward largely as a result of a flailing US Dollar. [The US Dollar Index declined just under 15% since its peak of 89.62 and its 2009 low of 78.33] Besides a weakening dollar, speculation that the Great Recession is nearly over has also turned sentiment on oil. These two factors, almost alone, have created the perfect bullish storm for crude prices. Rising crude costs have of course weighed heavily on prices at the pump.

Summer demand for unleaded gas and diesel is also adding to this run up, but only slightly. According to the EIA, gasoline demand is still off 2.9% from this time last year; which was one of the worst driving seasons on record. Fundamentally, global demand for almost all commodities is still weak and this weakness is even more pronounced in the energy/petroleum markets. In fact, regardless of any recent gains, demand for oil is still at a 10 year low.

In response to this weak end user demand, crude refiners have been trying to reduce inventories on hand and have been importing less oil. This is primarily the reason for the Energy Information Administration’s bullish inventory report Wednesday, which showed crude stockpiles down 4.4 million barrels to 361.6 million; better than the expected 700,000 barrel drop. It is also the reason the American Petroleum Institute reported a large draw on oil inventories Tuesday. So in saying this, it appears to me that overall supply is working itself out of the system, but not because of substantially increased demand or a scarcity of oil. Supply is working itself out of the system because of low margins at refineries and weak consumer demand; very different from a truly fundamental supply and demand shift. [Later in the week news hit the oil markets of Valero closing a major refining operation in Aruba for this very reason]

Question: Will the two continue to move in tune with each other this summer?

Response: Oil and Gas will almost always move in tune with each other; that is unless there is a bottleneck at refineries. According to the EIA report, most refiners are currently operating near 86.5 percent of capacity - far from bottleneck. Since consumer demand doesn’t appear to be coming back anytime soon, I don’t expect crude oil and pump prices to decouple during the summer.

Question: Many are saying that gasoline is a lot cheaper than it was a year ago. There are also some supposed signs of economic recovery that would imply that demand for fuel will improve this summer… if I’m not mistaken that should contribute to a higher price for oil, right?

Response: As I previously mentioned, we are not seeing a true improvement in oil fundamentals. No matter what the government or suppliers try to do or say, consumer demand is still very weak, period. I think it goes without saying that demand is likely to remain low until more people find work. Our now staggering 9.4% (and rising) unemployment rate strongly affirms this fact. [See “Believe None Of What You Hear, Half Of What You See”] Consumers without jobs cannot afford gas over $3.00 a gallon, while at the same time refiners and oil producers cannot operate at prices much under $3.00 a gallon. How quickly people forget the record oil profits that were generated when prices were well over $100/barrel and how demand wilted as prices climbed over $3.00/gallon at the pump. Let us also not forget that this was happening when people still had jobs!

Question: If the run-up in oil is not fundamentally driven, where are we headed? Is the worst of the economic crisis behind us?

Response: Although the broad markets and media tend to believe the worst of the economic crisis is behind us, I still do not entirely concur. At the risk of sounding foolish later, it is my current feeling that the worst of the crisis will be upon us within the next three to six months. If that is indeed the case, a retracement could drive fuel prices lower or near to where they were in December of 2008. [At that time fuel costs were about $1.65 a gallon nationally.]

To that point, it seems almost incomprehensible to me to consider a significant change in the demand outlook for crude over the near term. Certainly suppliers are trying and will continue to try and tighten up output, but that can only go so far. The more suppliers close up shop, the more they impede much needed cash flows. How can a company, or a country for that matter, service debt with no cash on hand? On top of this it seems that people are trying to look past the fact that the US is the largest consumer of oil in the world. So again, with ongoing unemployment claims rising, our unemployment rate climbing, and a geopolitical agenda that is pushing the world towards greener technology, where will increased discretionary income or demand come from in the near term?

Question: What will lead us to recovery then?

Response: We need to remove all bad corporate and personal debts from our financial system. We cannot continue to bail companies and individuals out forever. Around the world, not just within the US, the “save the economy” spending spree will have to eventually stop. At that time we must allow the system to reset itself through personal and corporate bankruptcies. As we now know through Lehman Brothers, GM, Chrysler, Indymac, and others, the world will not end if “too big to fails” fail and declare bankruptcy. The United States lived beyond its means for far too long and is now suffering the consequences of this lifestyle. So again, our debts need to be washed clean from the financial system before we fully recover and I don’t believe that has occurred yet. [Karl Denninger touched on this during the week, check it out]

Question: Any final thoughts on crude? Where will it be trading between now and the end of the month?

Response: As of now crude oil is starting to look a bit overbought and may be set for a pullback. This pullback should be even more pronounced if the US dollar is able to hold its footing. Over the past week the Dollar has hit technical support at USD Index 78.00 and has held. This, along with weak underlying fundamentals for oil, suggests to me that crude may be ready to turn between now and July. Until that turn, I expect pump prices to hold between $2.45 and $2.65 nationally assuming no more major refineries go offline. However, around mid summer to early fall I expect to see oil trade between $40 and $55 per barrel with pump prices coming in line. At that time I would expect them to start stepping down towards levels not seen since December of 2008. [For a more detailed discussion of my long term forecasts see “Oil at $25 a Barrel? Gas $1.50? The Time Is Coming Soon”]

Comments

[Peter Cooper:]

If you have a look at the Goldman Sachs' view on prices then oil is definitely the place to be - along with precious metals - there is a sense of deja vu all over again in comparison with the 1970s, see:
arabianmoney.net/2009/.../

Jun 14 12:47 AM

[Dave Wrixon:]

Two points really.

1) I am not convinced that Oil Companies and Producing Companies are so indebted that they will simply dump oil to satiate their demand for cash as suggested

2) I am not at all convinced that it is US demand for oil that is driving prices. Other nations are coming out of recession a lot faster than the US (OK, not if you believe the official figures perhaps). The falling dollar is also making oil comparatively expensive to Americans but has the effect of a price reduction for everyone else, albeit that may have to be offset against an underlying increase in the market value of the commodity.

"To that point, it seems almost incomprehensible to me to consider a significant change in the demand outlook for crude over the near term. Certainly suppliers are trying and will continue to try and tighten up output, but that can only go so far. The more suppliers close up shop, the more they impede much needed cash flows. How can a company, or a country for that matter, service debt with no cash on hand? On top of this it seems that people are trying to look past the fact that the US is the largest consumer of oil in the world."

Jun 14 04:32 AM

[Shalom Hamou:]

What is driving the price of oil is the restrain of supply from the producer: read my article:

Commodity Conundrum Solved: The Hidden Parameter in Interest Rates

seekingalpha.com/artic...

Jun 14 09:00 AM

[AaronWesley:]

I think a history lesson is in order. In the late 19th and early 20th century, there was but one oil company in the US. That company was the Standard Oil Company. It and a collaboration with the railroads formed an essential monopoly on commodities transportion within the US. This led to the Carnagie/Roschild/Bank of England control of transportation and energy. With tight control of supply in an oligopoly/monopoly, Standard grew to control the vast majority of oil, along with BP. Theodore Roosevelt recognized this problem and broke them up. Once there were many oil companies and the transportation monopolies were dissolved, market factors re-asserted themselves and the oil prices plummeted. But it was too late to stave off a speculative run up in the stock markets in the years prior to 1929. Like commodities futures speculation of today, this was done on thin margins mostly around 10% or so. Unlike the roaring 20s, the margins in use and widely cited are around 2-3%.
Once the market started to drop due to the unsustainable and irrational exuberance of the late 20s people sold their highly speculative positions or faced margin calls far in excess of their ability to pay. This culminated in the economic collapse that was with us through the 30s.

From that there came several laws, the most important of which was the Glass-Stegall Act which separated investment banks from savings banks and formed the FDIC. Our banking system stabilized and the production demands of WW II helped bring us out of the prolonged depression. The economic conditions in Europe and Asia also helped fertilize the ground for the commencement of the WW II.

Roll forward to the late 20th Century. In the 1990s, the Glass-Stegall act was altered to allow banks to re-enter the investment business, And they did, with a vengence. The result was the collapse of large banks. Investment banks of today, leading the speculative charge in the markets and the largely unregulated derivative and commodities futures markets, started slowly running prices up in the early to mid 1990s.

In the late 1990s, the oil companies were allowed to re-merge. (Amoco with BP, Mobil with Exxon, Texaco with Conoco with Phillips), until we had basically reconstituted the prime components of the Standard Oil Company of New Jersey (ESSO).

We set the precise scene for what is happening today.

Looking at the "oil embargo" of the 1970s. I grew up in an oil port town, the second largest on the east Coast. The vast majority of foreign oil flowed. The arrival tonnage was published each day in the newspaper in the form of Ship Tamarago, Liberian Registry Destined for the Pipeline Corp, carrying xxxx tons of Bunker C Arabian/Venezualan/Nig... etc /crude oil. As a kid, I loved to watch the big tankers come and go and I tracked it. There was no apparent decrease in tonnage during the "oil embargo." Maybe it was happening somewhere else?

Next, the development of "after hours electronic trading" requiring thin margins, and largely beyond oversight of the SEC and CFTC funneled small amounts of cash for the amount of delivered commodity. It was only a matter of time before this collapse occurred and in the exuberance of speculations like this, it spilled over into other commodities like real estate. A speculation driven economy will enrichen a few at a very large real cost to many, and will (in my opinion) ultimately correct and take down many more, possibly leading to a total economic collapse. This is very dangerous.

In the mean time, oil prices have been driven up by initially rumors and innuendo. When the oil companies first re-merged in the late 1990s, I predicted within a year, gasoline pump prices would double to $2.25/gallon. I was wrong. It took 3 months. Then congress threatened to investigate, gas gouging claims were rampant and the prices slid back briefly.

Then the rumors started. A refinery fire here, a pipeline interruption there, the natives are restless in Africa, etc. Each time it was a "reason" to raise prices. Did they ever return? No they never returned and their fate is still unlearned. Next Katrina which did virtually nothing to shut off oil production and refining, yet the price of fuel doubled to $3/gal and crude price speculation followed immediately. The record profits by the big 3 oil companies rivaled most national economies. Lest we forget, the prior profits were already very high.

Looking at costs of oil production. In the 1920s were were going to run out oil. In the 1970s we were going to run out of oil. The dates I remember were by not later than 2010. Well, 2010 is here, we have more oil proven reserves now than we did then. What does it cost to find the oil, and get it out of the ground and get it refined? I don't know these costs, but I suspect a lot less than the numbers we have been told.

Next, the Collapse of 2008. When you remove as much disposable income from peoples pockets by tripling the price of an essential transportation commodity it is inevitable that people will buy only essentials. This has happened and unemployment is officially at 10% and rising. It will continue because our demographics are changing. Baby boomers are retiring, they've lost their nest eggs in the speculative collapse, and they have the stuff they want and are not spending and don't need to spend. They are selling their vacation homes (or maybe their city homes) and disposing of excess assets. They will be drawing on what retirement funds they need to live and are available, further depressing speculative investment demand. It was no accident that the first TARP payout was very close to the amount of cash the oil speculative boom took out of the economy. It won't work because the speculation has tainted the broad economy, including housing.

I have no doubt we will find alternatives to commodities with monopolistic controls. The technology is being developed and the knowledge is there.

In the meantime, get ready for a very bumpy ride with many a hardship.

Jun 14 09:54 AM

[The Greates...:]

A nice article, for once someone has hit the nail on the head and wrote it in print. Last years run on oil was a bogus scam pushed on to the whole world for the sake of greed. Case in point, the one biggest lie was that demand was running a head of supply, this year clearly shows that to be true, as demand has fallen and now they are curbing the supply to raise the price of oil. This is the same thing they did last summer. We need to re-write the commodities market regulations and install term limits on Congress, with no exceptions. Way too much money in our government from the oil industry today. Greed is ugly.

Jun 14 09:58 AM

[The Greates...:]

Oil and gas were manipulated by the future traders last year and now the refineries are cutting back to reduce gas at the pump and drive up the price. I think the summer driving season will be driving to the back yard and playing in the kiddies swimming pool.
They are an estimated 10 million Americans out of a job today, Americans are driving less then they have since the 1950's.
Fluctuations and hyperactive are words being used for manipulation and control in the oil industry. Plenty of crude today, around a 19 year high, and yet the price of gas is on the rise.
We can all thank Phil Graham for that.
So how about something original lets regulate the futures energy commodities market? Or better yet, free us from the use of oil altogether? The oil industry as a whole made around $476 Billion in net profit over the last 6 years, the pulse of the worlds economy is under the thumb of 13 OPEC nations and 5 major oil companies. Is this the legacy we want to leave our children and grand children?

Jun 14 10:01 AM

[mouse85:]

Two major things not mentioned in analysis; Politics and hurricanes. Im bullish on oil until September.

Jun 14 10:06 AM

[Old Trader:]

One point this (and many other) articles pays scant attention to, is the demand from emerging countries. Granted, the US is currently the #1 consumer of oil, but in today's SA, there's an article that points out that for the first time ever, emerging countries/economies are consuming more oil than the developed countries. Does anyone think that this is going to change anytime soon?

Even when the US and the EU struggle out of the current recession, and start to grow again, the EMs will be growing at a much more rapid pace.

Jun 14 10:22 AM

[tresspass:]

True, old trader.

Now this: " No matter what the government or suppliers try to do or say, consumer demand is still very weak, period..."

true , it's weak---hello? we're still in a recession. but the market, so they say and have prospered by this parable, is a forward looking mechanism/forecaster. And, paraphrasing Trader, are we that ego-centric to still believe the US and Europe are the only land masses on Earth?

BTW, I'm open for education, what's in it for the US to try and convince us that oil supplies dropped last week and just may again 2 weeks from now?

Jun 14 10:46 AM

[manuel:]

can anyone explain me why oil goes up if the dollar goes down, and if oil goes up why does not the dollar go up? If people around the world have to buy more dollars to buy the same amount of oil as the price goes up, the dollar should go up as well?

Jun 14 10:59 AM

[manuel:]

considering the correlation

seekingalpha.com/artic...

Jun 14 11:01 AM

[Jimbo:]

I was very impressed by Aaron Wesley's lengthy essay. One small detail: Texaco was merged with Chevron, not Conoco Phillips.

Jun 14 11:30 AM

[Mayascribe:]

Both Bibbings' article/interview and Wesley's historical essay were great reads.

And unfortunately for us peons, both reek of manipulation from those controlling oil prices.

I only wonder how much money Goldman's Saks threw at oil stocks before they released their $85/barrel by-the-end-of-the-year prediction.

Jun 14 02:35 PM

[Midwest guy:]

I very much enjoyed the writers wit and logic.
You did a great job of presenting your case.
Thanks you for staying on point,I drop in on these boards to learn and I was not disapointed.
Thank you,AaronWesley


On Jun 14 09:54 AM AaronWesley wrote:

> I think a history lesson is in order. In the late 19th and early
> 20th century, there was but one oil company in the US. That company
> was the Standard Oil Company. It and a collaboration with the railroads
> formed an essential monopoly on commodities transportion within the
> US. This led to the Carnagie/Roschild/Bank of England control of
> transportation and energy. With tight control of supply in an oligopoly/monopoly,
> Standard grew to control the vast majority of oil, along with BP.
> Theodore Roosevelt recognized this problem and broke them up. Once
> there were many oil companies and the transportation monopolies were
> dissolved, market factors re-asserted themselves and the oil prices
> plummeted. But it was too late to stave off a speculative run up
> in the stock markets in the years prior to 1929. Like commodities
> futures speculation of today, this was done on thin margins mostly
> around 10% or so. Unlike the roaring 20s, the margins in use and
> widely cited are around 2-3%.
> Once the market started to drop due to the unsustainable and irrational
> exuberance of the late 20s people sold their highly speculative positions
> or faced margin calls far in excess of their ability to pay. This
> culminated in the economic collapse that was with us through the
> 30s.
>
> From that there came several laws, the most important of which was
> the Glass-Stegall Act which separated investment banks from savings
> banks and formed the FDIC. Our banking system stabilized and the
> production demands of WW II helped bring us out of the prolonged
> depression. The economic conditions in Europe and Asia also helped
> fertilize the ground for the commencement of the WW II.
>
> Roll forward to the late 20th Century. In the 1990s, the Glass-Stegall
> act was altered to allow banks to re-enter the investment business,
> And they did, with a vengence. The result was the collapse of large
> banks. Investment banks of today, leading the speculative charge
> in the markets and the largely unregulated derivative and commodities
> futures markets, started slowly running prices up in the early to
> mid 1990s.
>
> In the late 1990s, the oil companies were allowed to re-merge. (Amoco
> with BP, Mobil with Exxon, Texaco with Conoco with Phillips), until
> we had basically reconstituted the prime components of the Standard
> Oil Company of New Jersey (seekingalpha.com/symbo...).
>
>
> We set the precise scene for what is happening today.
>
> Looking at the "oil embargo" of the 1970s. I grew up in an oil port
> town, the second largest on the east Coast. The vast majority of
> foreign oil flowed. The arrival tonnage was published each day in
> the newspaper in the form of Ship Tamarago, Liberian Registry Destined
> for the Pipeline Corp, carrying xxxx tons of Bunker C Arabian/Venezualan/Nig...
> etc /crude oil. As a kid, I loved to watch the big tankers come and
> go and I tracked it. There was no apparent decrease in tonnage during
> the "oil embargo." Maybe it was happening somewhere else?
>
> Next, the development of "after hours electronic trading" requiring
> thin margins, and largely beyond oversight of the SEC and CFTC funneled
> small amounts of cash for the amount of delivered commodity. It was
> only a matter of time before this collapse occurred and in the exuberance
> of speculations like this, it spilled over into other commodities
> like real estate. A speculation driven economy will enrichen a few
> at a very large real cost to many, and will (in my opinion) ultimately
> correct and take down many more, possibly leading to a total economic
> collapse. This is very dangerous.
>
> In the mean time, oil prices have been driven up by initially rumors
> and innuendo. When the oil companies first re-merged in the late
> 1990s, I predicted within a year, gasoline pump prices would double
> to $2.25/gallon. I was wrong. It took 3 months. Then congress threatened
> to investigate, gas gouging claims were rampant and the prices slid
> back briefly.
>
> Then the rumors started. A refinery fire here, a pipeline interruption
> there, the natives are restless in Africa, etc. Each time it was
> a "reason" to raise prices. Did they ever return? No they never returned
> and their fate is still unlearned. Next Katrina which did virtually
> nothing to shut off oil production and refining, yet the price of
> fuel doubled to $3/gal and crude price speculation followed immediately.
> The record profits by the big 3 oil companies rivaled most national
> economies. Lest we forget, the prior profits were already very high.
>
>
> Looking at costs of oil production. In the 1920s were were going
> to run out oil. In the 1970s we were going to run out of oil. The
> dates I remember were by not later than 2010. Well, 2010 is here,
> we have more oil proven reserves now than we did then. What does
> it cost to find the oil, and get it out of the ground and get it
> refined? I don't know these costs, but I suspect a lot less than
> the numbers we have been told.
>
> Next, the Collapse of 2008. When you remove as much disposable income
> from peoples pockets by tripling the price of an essential transportation
> commodity it is inevitable that people will buy only essentials.
> This has happened and unemployment is officially at 10% and rising.
> It will continue because our demographics are changing. Baby boomers
> are retiring, they've lost their nest eggs in the speculative collapse,
> and they have the stuff they want and are not spending and don't
> need to spend. They are selling their vacation homes (or maybe their
> city homes) and disposing of excess assets. They will be drawing
> on what retirement funds they need to live and are available, further
> depressing speculative investment demand. It was no accident that
> the first TARP payout was very close to the amount of cash the oil
> speculative boom took out of the economy. It won't work because the
> speculation has tainted the broad economy, including housing.
>
> I have no doubt we will find alternatives to commodities with monopolistic
> controls. The technology is being developed and the knowledge is
> there.
>
> In the meantime, get ready for a very bumpy ride with many a hardship.

Jun 14 07:22 PM

[Old Trader:]

Tresspass,

Its not a case of "what's the US trying to say", its a case of the figure being quoted is the supply in US storage at the Cushing, Ok. hub. Oil has actually almost 300 different prices, all based on the quality of the crude, and its distance from points of usage. The most commonly followed oil benchmarks are WTI (West Texas Intemediate), a light, sweet grade of crude, and Brent (from the North Sea fields, not quite as a high a quality, but close, which usually trades at a slight discount to WTI).


On Jun 14 10:46 AM tresspass wrote:

> True, old trader.
>
> Now this: " No matter what the government or suppliers try to do
> or say, consumer demand is still very weak, period..."
>
> true , it's weak---hello? we're still in a recession. but the market,
> so they say and have prospered by this parable, is a forward looking
> mechanism/forecaster. And, paraphrasing Trader, are we that ego-centric
> to still believe the US and Europe are the only land masses on Earth?
>
>
> BTW, I'm open for education, what's in it for the US to try and convince
> us that oil supplies dropped last week and just may again 2 weeks
> from now?

Jun 15 02:09 AM

[Mad Hedge F...:]

Not very strong. I heard a little tidbit yesterday that makes me feel like I just ate a bad fish taco. Frontline, the world’s largest tanker company, says that it has 100 million barrels in storage, the equivalent of five days of US consumption, the result of the spectacular contango situation that exists in the crude futures market. Traders have been buying front month crude, storing it, and reselling it one year out for non leveraged profits of up to 75%. With spot now at $72.12, and futures for December delivery selling at $75.56, that spread has narrowed to an annualized 9.53%. The last crude top was made by the filling of the Strategic Petroleum Reserve. Could this intermediate top be put in by the filling of the world’s excess tanker fleet? This makes me worried not just about crude, but all of my longs in commodities and their producing stocks, the S&P 500, the BRICK’s, and everything else that has enjoyed a torrid doubling since the beginning of the year. Could gold’s poor performance this week, which dropped from $990 to $935, be the canary in the coal mine? And by extension, is it time to take profits on my short Treasury positions by selling the TBT, which has also doubled? There are just too many charts hanging around their 200 day moving averages to dismiss this lightly. I hate to sound redundant, but selling in May is looking more clever by the minute. Cash is King.

Jun 15 11:02 AM