Has Oil Peaked?

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 |  Includes: DBO, EIA, FED, GILD, USO
by: John Dalt

The EIA (Energy Information Administration) released last week’s inventory report yesterday morning. Crude oil inventory is down, but gasoline and distillates (diesel, jet A and home heating oil) are up. The lower inventory did not cause a rally in crude prices as one would expect. The larger supply of gasoline and distillates is viewed as a weight holding the price down. Unleaded gasoline was down 2%

If you have followed crude oil and traded the USO, DBO or DXO during the last few weeks, you have had a great run. You probably are wondering how to play this train for another great ride. Get ready. Do not look at the overhang of refined products as a block to higher prices. Look at them as a lever to push crude higher as they work off. Just like a teeter totter on the playground, when the refined end goes down, the crude price goes up!

Refiners will work to tighten inventories to reduce their exposure to hedging, and increase the crack spread (markup). OPEC wants higher prices, and has instituted production cuts. Member producers have not complied with their quotas, as they try to maintain income. While the market is under a glut, it is hard to reduce production. When prices are trending up, production cuts become rational, as the price may be higher next month.

Mankind is hardwired to overproduce, increasing supply to maintain previous income. Rising prices encourage holding supply from the market in anticipation of even higher prices. These psychological forces are ingrained in every marketer.

The following charts are our familiar stocks and days of supply. The closer the red line gets to the blue lines, the higher crude will go. Now is not the time to walk away from this market.

Inventory 61209

Days of Supply 61209

An interesting feature in this week’s EIA report is First Quarter Profitability of major oil companies on domestic operations. The EIA calculates the average crude oil price at $40.13 during the first quarter. Natural gas averaged $4.35 per thousand cubic feet (Mcf), compared to $10.04 in the second quarter of 2008.

I have written many times how we have forgotten about “peak oil”, and the future is being written now. Low prices are causing exploration budgets to shrink. Following are two charts that graphically show the reduced income for the majors, and reduction in capital expenditures. Lower investments will slow the discovery of productive oil fields, resulting in lower production in the future, when we need it.

Producers Net Loss, Refiners Net Gain (Billions) by Quarter

MajorOilCompanyProfits

Producers Capital Expenditures (Billions) by Quarter

CapitalExpenditures0109

If you are interested in the crude oil market for trading or just wonder how yesterday’s actions are going to affect you, view this week’s EIA Petroleum Report. Remember these charts when politicians want to raise taxes on oil companies.

Did you know that Gilead developed Tamaflu? Roche Holding produces and markets it, but pays Gilead a 20% royalty on sales. Tamaflu is one of two drugs used to treat H1N1 flu, now declared a pandemic. Flu season may turn into a cash register for Gilead (NASDAQ:GILD) as governments order supplies of drugs.

Oh! Bama proposed sweeping changes to the regulation of the financial sector. No explanation was given why the regulations in effect did not head off the collapse in 2008. Was it because some of the regulation changes, Federal Reserve policy of cheap money, and congressional interference in the mortgage market caused of the meltdown?

I wrote last year that Chris Cox, head of the SEC should have been fired. He sat on his hands and did not enforce naked short selling rules, while predatory short selling ravaged financials. It was unbelievable to watch, week after week. I read Mr. Cox’s resume and was hesitant to criticize him, but he did not do his job.

Of course, neither did others. So now, we get more regulations, and more bureaucrats that will not do their job.

The SEC could not catch Bernie Madoff, when he was handed to them by a whistleblower. If you do not believe it, watch this clip of Harry Markopolos testifying before congress. He contacted the SEC for over 8 years, alerting them to the Madoff ponzi scheme.

Disclosure: No Positions