Crude Oil: Where to Next?

Includes: DBO, DUG, OIL, USO
by: John Dalt


The real surprise today was the reaction to the Energy Information Agency (EIA) report. Crude inventories continue to build. Crude Oil stocks increased 2.5 million barrels, gasoline decreased one million barrels, and distillates increased 800,000 barrels. Add them all together and we have 2.3 million barrel build in inventory. Crude oil dipped then regained to lose only fifty cents after the report came out! We have all heard that the market can stay illogical longer than you can stay solvent; we are witnessing illogical movements in the oil market.

The market is anticipating an increase in oil usage with increasing economic activity. While the stock market has been on a nice run for the last few weeks, and is bumping resistance at 1007, this is an imperfect predictor of a recovering economy. Crude oil is used for transportation, natural gas is used for production.

Crude, gasoline and diesel had a net build of 600,000 barrels last week and the net build in inventories the previous week was 4.9 million barrels! I have called crude oil the trade of the year, but you have to be willing to step aside, and take profits, when the fundamentals are going against you.

Some more statistics that cause us to turn bearish on oil, for the short term. Refinery inputs are down 1.7% in the last three weeks, and down 4.5% from last year. Gasoline production is down 1.3% and distillates down 4.2% in the last three weeks.

Following are our two familiar charts that graph the inventory and days of supply, both are moving in the wrong direction for higher crude prices.

Crude Oil Inventory 8/5/09

Days of Supply 8/5/09

Our conclusion for your consideration, oil is trading on vapor. A reflection of the larger market advance. Don’t step in front of a truck, especially a diesel, but if the current market enthusiasm wanes crude will fall harder and faster than the general market. Short USO, buy DUG, or if you are brave and have nerves of steel, short DXO.

The Federal Open Market Committee (FOMC) kept interest rates the same, and extended buying treasuries into October, rather than ending in September. The market was up before the news, and then accelerated higher. The report stated that inflation should be “subdued” as unemployment and idle capacity will limit the ability to raise prices. The Fed said unemployment is likely to top 10%, as companies will be slow to rehire. This is after unemployment dipped to 9.4% in July. I have no doubt that will be corrected in a future report.

Disclosure: Long DUG