5 Reasons Oil Was Thrown Off Track

The game plan was that the Fed was done and the economy suddenly seemed not so weak, so the dollar would continue to strengthen. Plus the Saudis are bringing on their last big new fields this year and next. Plus oil demand growth is slowing all over except among the oil exporting countries. Plus oil tried to bust $120 for a while and failed after a long and strong rise. So clearly the fundamentals and the technicals are aligned to say that oil is headed for a correction. Right?

And right on schedule oil headed down for a test of $110, which held. It seemed like everyone was following the script, but then things went kaplooey. What’s happened? Well, there are a number of suspects who might resolve this mystery.

1. The dollar stopped getting stronger. That might be partly because a number of analysts over the weekend explained that last week's miraculous Q1 GDP number up .6% annualized was, like a lot of miracles, a bit questionable. It depended importantly on the assumed inflation rate on which the government might have been a tad optimistic, thus reporting stronger GDP than may actually be the case. Furthermore, last week’s report of only a small loss of jobs last month - 20,000 - was also a function of an assumption, this time something called the birth/death number that relates to smaller businesses. Their birth/death assumption turns out to be highly questionable and it resulted in a jobs report that may have been vastly off base. So, bottom line, the economy may be a lot weaker than the reports had caused the stock and futures markets to assume it was. Monday, those markets corrected, taking the dollar down and gold and oil up.

2. Things are getting worse in Nigeria, aggravating recent oil supply problems caused by the British strike and previous Nigerian supply disruptions. I cannot accurately describe what is happening in Nigeria. I’m not sure many people really know. A comprehensive report on the Nigerian oil situation in April’s Petroleum Review titled, “Risky Business” is the stuff of movie scripts - think Casablanca. It seems the authorities are involved in the crimes. The report says that when a kidnapping occurs, a fairly regular event,

“It tends to be the norm that SSS - the state security service responsible for intelligence within the country - already knows who the perpetrators are and in what circumstances the hostages are being held.”

Moreover, MEND, the militarily sophisticated rebel group that is supposedly seeking social justice, has become more efficient. They have warned that during their attacks on the oil infrastructure, if any security guard returns their fire he will be killed. The result is that the guards flee when MEND arrives. There is little or no effective security for the oil infrastructure now. MEND (which may be short for “mendacious”) recently vowed to shut down the entire oil export business. I doubt that would happen because MEND needs the oil companies to be producing oil so that MEND can steal it. Still, Nigeria used to supply 2.3 million b/d and now they are down a lot. I’m not sure how much, but the direction seems to be south.

3. It is starting to appear that the Saudis are saving whatever spare capacity they may have in case there is a true global emergency. Thus, they seem not to have additional spare capacity to simply make up for ordinary supply disruptions such as Nigeria and Bournemouth. Perhaps when KSA brings on its new fields sometime later this year and next, they will be more capable of bringing discipline to the oil markets, but at this point they seem to have lost any pricing power on the upside.

4. It is also starting to seem that the Bushies are increasingly serious about reducing the Iranian military involvement in Iraq. They frequently refer to a “price that must be paid” by the Iranians for interference. Clearly they are now pushing to put out new carrots. But it feels like they know the carrots will be rejected and they just want to get the gesture out of the way to clear the field for other actions. What sort? I would guess there could be limited strategic bombings of munitions factories and similar targets.

A military strike against Iran could well bring chaos to the oil markets. No doubt that would bring on whatever reserves KSA has, plus there would likely be releases from the Strategic Petroleum Reserve in the U.S. and other countries. Still, the possibility of a Bush military strike against Iran is a growing threat to anyone short of oil.

5. Which brings me to a major participant in the surprise oil rally: short covering. It appears that all the reasons advanced above for oil to fall had attracted a significant number of shorts to the oil market. Apparently, there was a mass exodus of the shorts from the oil market Friday and Monday, as oil topped $120.

We are living in interesting times.

Comments

[lowem]

MEND stands for the Nigerian "Movement for the Emancipation of the Niger Delta".

[zenalgorithm]

Meanwhile, oil and gas surplus supplies increase in the U.S. because of demand destruction from $4+/gallon...

[galewhitaker]

Jim
What mystery are you talking about. The world has passed peak oil and since we are not prepared all hell is going to break loose. You conservatives have been laughing at us alarmists for a long time. Lets see who gets the last laugh.
Gale

[CommodityBubbleproponent]

Let's look at reality. Nobody knows who in the hell is buying what b/c of the OTC derivative markets. If we had a major supply problem (a big if btw), then please explain to me this.

1. Iran has 20 million barrels of oil sitting in oil tankers they can't sell. www.bloomberg.com/apps...

If demand was truly outstripping supply, do you think this would happen? NO

2. Saudi Arabia just LOWERED the prices on their benchmark crude for delivery to Europe and North America.

www.bloomberg.com/apps...

If demand was truly outstripping supply, do you think this would happen? NO

Oil, gasoline, and distillate inventories are at the upper half of the 5 year average range.

In reality, three things have distorted this market.

1. Negative real interest rates in every major currency around the world. Inflation is hotter than 4% in Euros, contrary to the ECB argument, making even interest rates in that currency negative.

2. Dollar weakness

3. The securitization of commodities: We clearly need more transparency in the market. It'll be interesting to see what happens to these ETFs, commodity speculators once Congress closes the Enron loophole with the next farm bill

OPEC still has between 2-3 mbd of spare capacity according to the EIA and IEA, a big increase from the .5mbd spare capacity in 2004.
A special message for gale: I expect better out of a seeking alpha commet. Even if you're right, you can't stop it and you're just as screwed as the rest of us if society crashes. Maybe you should go hide under a rock on a tropical island with your little Hubbert curve graph instead of annoying people with your alarmist bs. You are really a wuss of the worst kind. Back up your rhetoric with some action.

[maher]

Finally, a writer mentions the coming Iran war as the real reason behind oil going Ga Ga. Finally!

[maher]

After the initial airstrikes on initial Iran targets, oil will spike, if Iranian regime retaliates in any way, shape or form; the second trap comes in: then Bush will have the perfect grounds for exacting the real aim which is massive bombing of Iran involving up to 2000 targets. Oil will most likely spike to $175 towards $200. But then US and Saudi will open up their reserves which will cause oil to drop back to $120 again.

Let mullah heads roll then.

[JREwing]

This site is screwed up. There are more and more nutjobs writing comments, who seem to care more about political implications, than money.

THIS IS A FINANCIAL BLOG SITE. THE ONLY THING THAT MATTERS HERE IS TO MAKE MONEY OF ONE THING OR ANOTHER!

So please nutjobs, who think W is responsible for everything,(he's not that powerful!) PLEASE TAKE YOUR PROPAGANDA SOMEWHERE ELSE!

I BET THERE ARE A MILLION SITES WITH THAT KIND OF CONSPIRACY NONSENSE!

THAT'S THE PROBLEM WITH YOU PEOPLE. YOU SPEND SO MUCH TIME BLAMING OTHERS FOR THE CRAPPY LITTLE LIFE YOU LEAD; THAT YOU FAIL TO MAKE MONEY: IF YOU MADE ENOUGH MONEY; YOU WOULDN'T HAVE TO GIVE A RAT'S ASS ABOUT ABOUT THE PRICE OF GAS!

GET LOST!

[benisanidiot]

crude oil prices are being manipulated ... and the bloody authorities are not doing anything about it

how do you explain this constant run-up and the underlying volumes and big trades, and all the suspicious going-ons?

see below:

atimes.com/atimes/Glob......

news.yahoo.com/s/ap/20...