Is Oil's Recent Rise Merely a Head Fake?

Oil rose to $73.90 (Aug. Nymex Crude) on June 11. It then retreated to a low of $66.37 in what many thought would be a major retreat down to the $55 to $60 range. It has since risen to close at $70.26 on Thursday June 25. Some are now saying that this means we are going to see a big further rise in the near term. Others are saying that this means the new range for oil will be in the $65 to $75 (and up). I beg to differ with both of these opinions.

This latest spurt upward has simply been the result of very bad geopolitical news conspiring with other events to push oil in an abnormal direction for the near term. For instance, the civil unrest in Iran has contributed. Iran is the fourth largest producer of oil. It has the third largest proven reserves behind only Saudi Arabia and Canada. Other recent news includes an attack by MEND on the Nigerian oil supply. The latest incident was a claim of sabotage on the Billie-Krakama pipeline in Rivers State, which supplies one of the country's main export terminals. Attacks by MEND have forced foreign oil producers to shut at least 133,000 barrels per day of oil production in the last month. Adding to these problems, XOM’s huge Baytown Refinery has recently been having operational problems.

Oil could continue to rise on future prospects alone, but that is not likely. The fundamentals are not there for oil. Even oil does not want to get too far ahead of the recovery curve. The total crude oil and petroleum stocks in storage in the US on May 30, 2008 were 1,672,516,000 barrels. On May 29, 2009 the total was 1,824,313,000 barrels. This is an increase of about 9% year over year. That is including the SPR. If you remove the SPR, the data are 968,414,000 barrels on May 30, 2008 and 1,102,613,000 barrels on May 29, 2009. This is an almost 14% increase year over year. The total petroleum products supplied in the 4 weeks ending 6/19/08 were 19,616,000 barrels. The total petroleum products supplied in the week ending 6/19/2009 were 18,320,000 barrels. This is a decrease in usage of about 6.6%, although gasoline use was nearly the same both years. Plus there is a considerable amount of oil currently being stored in tankers floating off the coast of the US. With less usage and more supply, there really should not be upward pressure on oil, especially with an economy that shrunk -5.5% last quarter.

Likely some of the reason for the price increase is that the US is storing more oil. Some of it is that China is storing more. However, both of these activities have been going on for some time now. Only recently have we seen glimmers of hope that the US economy has been improving. That is what seems to be driving the price up now. It has obviously driven the equities markets up as well during the same time period. Still Dr. Roubini has recently been touting the likelihood of a W-shaped recovery due to the recent spurt in commodities prices. If these prices don’t correct soon, Dr. Roubini may be correct again.

Mutual funds, hedge funds, etc. are likely doing some window dressing buying for the end of the quarter (end of June). Plus there is a tremendous amount of money on the sidelines. Some of that is probably finding its way into the markets. However, in equities we are overdue for a good sized retracement. After the end of the quarter, we may get one. The big push in oil for the July 4 holiday will soon be over. The earnings season for Q2 will soon be upon us. Most think that Q2 earnings will be much more disappointing vis-à-vis the estimates than Q1. The Unemployment claims were worse than expected June 25. The window dressing by funds will end with the end of June. The full fury of the automakers bankruptcies will soon be felt.

The equities markets seem likely to swoon. The equities markets seem likely to take oil prices down with them. The prediction of a $55 to $60 bottom for this fall seems reasonable to me. This would fit reasonably well with the EIA prediction for an average price of $67/barrel for the rest of 2009. It does not even conflict with the GS prediction of $85/barrel oil by the end of this year. I believe this drop to $55 to $60 should happen in the near term. More than that I am hoping it does. I am inclined to believe Dr. Roubini’s prediction of a W-shaped recovery if commodity prices stay this high. I hope people are wise enough to realize that Dr. Roubini is correct again. Don’t buy into rampant speculation. It will likely hurt you financially. It will almost certainly derail the recovery, if it leads to still higher commodity prices.

I cannot possibly predict the geopolitical futures of Nigeria or Iran in this article. Still it appears that the mullahs and the president's government will be able to retain power in the short term. The situation may eventually erupt, but that is likely to be farther into the future. Nigeria will no doubt remain a hotbed of rebel activity.

Comments

[Mad Hedge F...:]

For sure. 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 26 10:21 AM

[Larry House:]

I agree with your caution on equities. It would appear there is little to gain and possibly much to lose at this point.

Jun 26 03:40 PM

[The Greates...:]

With the amount of excess crude in the world today, Nigeria is some of the same smoke & mirrors excuse that was used last 2008. Crude pricing today is un-supported and the bubble will burst very soon.

Jun 27 09:44 AM

[Ferdinand E...:]

"The fundamentals are not there". Hmm. I have sent a short paper to our friends at SA arguing that the most important part of the fundamentals is the supply policy of OPEC. Therefore, I regard that statement with some suspicion.

Occasionally I think about what I would do if I were the OPEC people. No point in being greedy I say to myself. Wait until it is clear that the global macroeconomy is getting better, and then fix the price somewhere in the vicinity of $65/b. There are some other details that might be relevant, but I don't want to bore anybody with them.

Jun 27 10:05 AM

[CLH:]

I agree with you that oil is overpriced but disagree with your reason. I expect equities to go up as things get better but also because oil will drop (to 30-40 dollars). Of course if this cap and trade becomes law I will be wrong as equities go down as oil goes up. I consider cap and trade the worst thing that could happen to our nation.

Jun 27 02:19 PM

[galewhitaker:]

Since the world currently uses 85 bb/day the fact that there are currently 44 bb stored in ships ( www.businessinsider.co... ) means nothing. 44bb is only enough for 12 hours at the current consumption rate.

All the world’s major oil fields are in decline and the oil industry is not going to be able to maintain the current production rate (85 mbpd) much longer. New demand by china and India (maybe a billion new Nano cars sucking up oil) are going to guarantee that demand outstrips production in the not too distant future. This will cause shortages, economic recession and political chaos. I know I am pissing in the wind but I can’t resist blogging about our real situation. Conservatives just cannot fathom the idea that god hasn’t provided enough oil in the bowels of the earth to last forever. Let’s wake up guys, even a child can see that if you keep sucking the oil out of the earth it will eventually disappear. www.hubbertpeak.com/

Jun 27 03:50 PM