Has Oil Peaked?

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.

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

Producers Capital Expenditures (Billions) by Quarter

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 (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

Comments

[Respirate:]

I agree wholeheartedly that so-called efficient markets routinely fail to work over the short term. "Low prices are causing exploration budgets to shrink. Lower investments will slow the discovery of productive oil fields, resulting in lower production in the future, when we need it."

On SEC regulation, was it a matter of inability to regulate, or willful neglect?

--R

Jun 18 08:04 AM

[Ferdinand E...:]

OPEC member countries have not gone along with quotas as they try to maintain income. I seem to remember doing some algebra about twenty years ago using this theme, and came to the conclusion that in another ten or so years they would wise up. So, think about what might happen in order for these countries to "maintain income".

Jun 18 09:05 AM

[prairiedog555:]

Headlines yesterday: "oil falls as inventory rises"
Headline today: oil rises as inventory falls"
That is not verbatum, but close on Yahoo Finance.
Energy price is manipulated by speculators, like all commodities.
I am an avid investor, and I used to run a LV casino, and I find very few differences in stock market investing and sports betting. So I like to do both. Just have to figure where the smart money is going.

On my tombstone

When the one great scorekeeper looks to your tally when you are dead,
He'll ask, not if you won or lost,
But if you beat the spread.
Amen.

Jun 18 09:05 AM

[Shale Gas:]

The real question is how much production will be added based on the peak capex in 2008?

Jun 18 09:32 AM

[Mad Hedge F...:]

the risk/reward here has certainly lessened. First of all, let’s get some facts straight. No one is buying oil here at $72 because they plan to burn it, use it to drive more miles, make asphalt or plastics, or rub it all over their bodies. They are buying Texas tea because they hate the dollar and there is no other surrogate reserve currency. Some of the biggest buyers of crude now are the oil producers, desperate for any appreciating asset they can park their revenues in size. This is why you can now walk across the Caribbean and not get your feet wet, jumping from one storage tanker to the next. The world is choking on surplus crude. Does anyone see anything wrong with this picture? Even perma bull Boone Pickens has a target of only $75. I hope he remembers to sell this time (sorry for the cheap shot Boone). The problem is that when you have so many hedge funds, financial players, and non consumers bunching up in a trade, the turns can be particularly vicious. All it would take is a little more evidence of a double dip economy, or even just an innocently strong dollar. Watch those green shoots with a magnifying glass.

Jun 18 11:26 AM

[Larry House:]

This is a good time to just lie low for a while and watch all the markets. There isn't much to get excited about in any asset class.

Jun 18 02:29 PM

[one eye:]

According to a recent NYT article brought to my attention, there has been a recent 35% adjustment in NG reserves in the USA

NG took a hit today because of the Report.

Too Bad about the Headline Fake Out, In actuality, if one reads the Full article, the entire increase is due to Shale Gas Reserve estimates. And if one removes, the Shale Gas estimate there is A Slight Decrease.

Current Technology requires prices in the $4-$6 range to extract and the Entire process is starting to receive environmental opposition, Water Table Pollution.

So, unless, some other means can be found to extract same, I fear these New Reserves might fall into the Category of Unrecoverable.

Just an Opinion mind you, Environmental concerns have always played a Big part in the Obama camp.

Will he go against their concerns?

Jun 18 03:34 PM

[The Greates...:]

Remember all the reasons for the ridiculous run on crude last summer? It was all because demand was running ahead of supply, now that the worlds full of crude, they are squeezing the consumer at the pump trying to make another man made shortage. Also, all the oil companies trying to show loses for the first quarters are basing these loses on last years numbers. And we all know that was bogus, so please no more news about how big oil is going through loses this year. Oil companies as a whole have generated around $476 Billion in net profit over the last 6 years. Look for a repeat of the summer of 08 in 09 as the oil companies raise the price by manipulating the energy commodities market once again. And your Congress turns a blind eye to this as they reach their hand out behind their back for their cut of the oil revenue pie. Greed is ugly.

Jun 18 07:55 PM

[sanvick:]

Long crude has been a great trade this year. I see lots of green on my trading screen. I don't care that the market is phony, the object is to make money.

Jun 19 06:55 AM