Oil prices and relative sector stocks have swung back and forth over the past two days, seeming indecisive and without reason for some. However, the moves can be easily explained and future moves, therefore, better understood. Oil prices spiked Wednesday even as the dollar strengthened on the Fed fumble. Yet, Thursday oil prices were lower on the ECB inaction and resulting dollar strength. That might leave some confused about what exactly is driving oil.
The iPath S&P GSCI Crude Oil Index ETN (NYSEARCA:OIL) and United States Oil (NYSEARCA:USO) rose 1.5% each Wednesday, even as the PowerShares DB US Dollar Index Bullish (NYSEARCA:UUP) gained 0.7%. The move didn't make sense, because when the dollar strengthens, oil and gold tend to move in the other direction. The Fed fuddle led me to suggest investors take advantage and buy gold, which I favor long term. Oil is a more complex trade, though, as evident by the back and forth of the last few days.
The thing is, Wednesday's move wasn't dollar-driven, and in fact was so important it completely muted the impact of the Fed. Believe it or not, there are still other factors at play for the energy complex (like Iran, for instance). This time around, it was supply that was affecting things.
The EIA Petroleum Status Report produced a surprisingly dramatic draw from oil inventories. In the week ending July 27, crude oil inventories decreased by an astounding 6.5 million barrels and total motor gasoline stores fell by 2.2 million barrels. Gasoline inventory measured in the lower half of the average range for the season. The crude draw left oil stocks still above the upper limit of the average range for this time of year.
Thus, the surprise oil draw drove it higher against the dollar tide that would have otherwise swept it away Wednesday. It supported the commodity's dependents as well, including the major integrated oil and gas companies.
Company & Ticker
Exxon Mobil (NYSE:XOM)
China Petroleum & Chem. (NYSE:SNP)
Occidental Petroleum (NYSE:OXY)
Total S.A. (NYSE:TOT)
Eni SpA (NYSE:E)
After Wednesday's confusing price move and without any other significant industry driver, we reverted to normal oil/dollar trading Thursday. Thus, as the ECB's inaction gave the dollar relative strength, it sent oil lower. The revenues and profits of the companies listed here are so closely tied to the price of the commodity that they tend to swing with it. Therefore, this explanation is critically important to the shareholders of these firms. Of course, corporate-specific information plays its role for those "seeking alpha."
The ECB and Fed also left the market wondering just what more central banks could do. I'll tell you what more they can do, then: They can further dilute global currencies and give life to inflation or even stagflation. Commodity markets, including the one for oil, are not looking that far ahead today, though. So we have the dollar strengthening against the seemingly unsupported euro, plus on increased concern about the global economy. As a result, oil prices and relative stocks move lower.
What happens next depends on what you see for the dollar and oil supply and demand. Some sort of new Fed action is expected in September, and that would weaken the dollar and bode well for oil and gold. However, the global economy appears to be decelerating, and so the demand side of the oil price equation is softening. Plus, oil substitutes are constantly increasing in importance. For instance, the glut of natural gas in the U.S. will lead to increased use of the fuel in place of oil in currently competitive uses (like heating) and in new areas of use as well (like through fuel cell technologies). And then there's Iran, which despite increasingly being rendered less important in relation to oil prices, represents a significant event risk that will not go away. Oil price dynamics are complex, so we'll keep working at determining what's next for the energy complex.