Where Does Oil Go from Here?

As oil prices top $125 and take other energy prices higher, where do oil prices go from here? Crude oil appears to be overbought in the short term but sentiment doesn’t seem to be at a bullish extreme, indicating that there may be more upside in black gold. However, oil does seem to be extended relative to other commodities.

Fast money is in a natural gas crowded short
A look at the CFTC commitment of traders data shows two different faces of sentiment in the energy complex. While natural gas prices are nowhere near their all-time highs, large speculators (read: hedge funds) are showing record levels of skepticism in natural gas and they are net short the commodity. Readings are not only at a crowded short level but their bearish positions are off the charts.

Hedge funds long crude but not excessively bullish yet
By contrast, large speculators are net long crude oil but readings are not at an extreme level despite the record oil prices. This data from the CFTC, combined with public sentiment readings, suggests that in the absence of excessive bullishness in crude oil, the commodity does have room to move a bit higher given its positive price momentum.

Buying natural gas seems less risky than buying oil right now
The contrast in sentiment readings suggests that natural gas prices have more upside potential than oil prices and could hold up better should the energy complex correct. The chart below shows the price ratio of natural gas to crude oil, along with its long-term average and the one standard deviation bands around the average. I highlighted the price divergence between these two commodities in December and again in February. The natgas/oil ratio bottomed out in late December and has since turned up but likely has more to go.

A long natural gas/short crude oil position would have a potential upside of 15% today, based on the conservative target of reaching the lower one standard deviation band. If we assumed that the ratio moved up to its long term average, the position would have a profit potential of 50%.

Oil looks extended against gold too
Another way to look at oil is to look at its performance against gold. The chart below shows the price ratio of gold to oil since 2000. Gold prices topped out against oil prices in late December 2007 and the ratio reversed itself dramatically. Oil now appears quite extended relative to gold, as it does against natural gas.

The commitment of traders report on gold (not shown) shows that sentiment readings are relatively neutral. As a result, I would prefer a long natural gas/short oil trade rather than a long gold/short oil trade.

Comments

[NOWHEREMAN:]

The first support for WTI will be around $120 but I would not be surprised if it dropped to $110.

Meanwhile, even if you use $8 per BTU, on a converted basis Nat. Gas would be fairly valued at $15.

Meanwhile, Opec has reiterated that it will not reconvene until September...could it possibly be that they do not have any spare capacity currently?

No one knows how much they are using internally.

2008 May 12 09:11 AM

[Ker:]

Oil to revisit 115 and then to $140

2008 May 12 09:28 AM

[cdcaddy:]

Why would OPEC meet? There is supply...and when was the last time you complained about getting "paid too much"? These guys are wringing their hands and frothing at the mouth...they now have all the clout and the shift in financial power is blowing their way...

Oil is off to the races until we rein in our consumption or find an alternative to replace it...

2008 May 12 11:39 AM

[Vikking:]

I find comparing natgas and oil to be a futile endeavor. Why not throw plutonium,uranium,wood... oil,strength of sun rays and the wind into your chart while your at it? they are all forms of energy right? oil is unique only because our present and near term infrastructure demands it to function and our infrastructure does not change as quickly as the price of a barrel of oil. from what I understand most natgas that is discovered is either burnt off or pumped right back into the ground where it came from, I have never heard the same in respect to crude. I can not go fill my car or oil heater with natural gas if the cost per BTU is better on it tomorrow.
Is there a correlation between natgas and crude prices? maybe, but it could have more to do with the fact that the industry's that produce them share cost increases (labor, taxes, equipment and suppliers).

2008 May 12 06:19 PM

[GKM:]

Let's look at a couple of the other extremes on the chart to see if hedge funds are truly contrarian indicators for nat gas's direction. In Jan/00 they were long and prices ran up. In Jan/03 they were long and prices rose. In Jan/04 they were short and prices fell. In Jan/07 they were long and prices ran up.

From this you conclude that because they are aggressively short that prices must rise? I think I'll stick with what the fast money is doing based on their track record. Trading is a zero sum game and someone else is equally as long - likely those with a worse track record.

John Arnold is one of those traders. He made over a billion in bonus when he blew Amaranth and Brian Hunter up because he was on the other side of the trade. Fast money is fast money for a reason and I wouldn't be standing in front of them on the off chance that they are wrong this time.

2008 May 12 08:26 PM

[fanning:]

If oil price stays high for a feww more months,nat.gas and gold price will catch up later.

2008 May 12 11:49 PM

[TARP:]

It makes no difference who's long or short. The reason why crude is so high is because the producer/supplier national are not pumping enough for the demand...It's not that the demand is out pacing the supply. It's more that the suppliers do not want to meet the demand so prices will rise. Remember back in the 80's when Bush Sr. went into Iraq because they were burning the oil wells by the thousands in Kuwait. Think about it, there was no alternative fuels like today. There was black skies of oil soot traveling to China, Europe and the Middle East for months and every ship with crude from the Middle East has to have a military escort. But the price of oil was between $27 - $30 a barrel because the Saudi's increased their output to over 80% with ease. Today we have Nigeria no producing due to war. We have Chile with strikes and Chiaves laying off 20,000 oil workers just to stop the output no doubt (He and Bush really are partners. The devil is in the details). And the US is buying millions of gallons of oil off the market to add to the largest reserves in the world. Oil demand is down -95,000 barrels in 2008 but the prices keeps rising.

I tell you when the oil producers decide they made enough money they will pump more oil and the price will drop like hot lead into butter. The North Sea stopped the 70's fake oil shortage. OPEC stopped IRAQI one from high oil prices. Clinton stopped OPEC from rising prices just before he got out of office and just by threating to release oil reserves. Russia, The North Sea, USA, Chile, Nigeria and the Middle East are holding back while oil prices keep rising. The alternative fuel that will stop it all Hydrogen the most abundant substance in the universe is at our doorstep. The oil whores know it and are charging all they can while they can.

2008 May 15 01:28 AM