Don't Buy Oil, It's Already Too Late

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Includes: BNO, DBO, DNO, DTO, DWTI, OIL, OLEM, OLO, SCO, SZO, UCO, USL, USO, UWTI
by: Matthew Allbee

Summary

With the price of oil skyrocketing over the last few weeks, many are wondering whether now is the time to go long in crude products.

The rising price cannot be related to any fundamental factor, though, but to jawboning, profit-taking, and speculation by traders.

In this article, I show fundamental oil market dynamics and oil trading dynamics should prove to you that it is already too late to catch the upswing.

With WTI Oil (NYSEARCA:USO) finally pushing through $40, I've seen many comments on various financial sites asking whether now would be a good time to buy into oil. A completely reasonable question; whenever a deflated asset suddenly roars back to life, investors begin to ask themselves if they now have an opportunity to ride it back up. In this article, I will give my take on why it is already too late to buy oil.

Let's get one thing straight: Oil at $20 and $30 per barrel is unsustainable. You'll see at the bottom of this article that I am actually short oil. I will explain why in more detail later, but it is important to understand that I don't see any reason for oil to fall below $30 long-term. In fact, if you can get into a long at below $30 oil that you can hold for a few years, it will probably end up paying off nicely.

With that being said, oil +$40 is unsustainable right now. While oil has risen sharply over the last weeks on jawboning, profit-taking, and snippets of positive data, the current fundamentals and oil market conditions cannot support these levels. There are two reasons for this: increased supply as price rises and oil trading market conditions.

At around $45, many of the producers that OPEC has been trying to shut down through their price war will become profitable again. The closer we get to that number, the more likely it is that production will ramp up again. Also, there are significant amounts of oil sitting in storage just waiting for an opportunity to be sold. As oil prices rise, this oil will also increasingly come into the market.

It's simple supply and demand, really. As prices rise, so does supply. We already have a supply glut, though. The current equilibrium between supply and demand is below current prices, and the market will always move the price towards this equilibrium.

The second reason why oil prices are unlikely to see much further upside is the current dynamic in the markets where oil is traded. The daily RSI for WTI is above 70. The last time daily RSI was around these levels, oil prices were reaching their peak in the $45 to $60 rally early last year. Oil prices are likely to find significant resistance throughout the $40-$50 range. As this article shows, hedging by oil producers will bring downward pressure throughout this range as well.

While not a tangible indicator, I think it is also important to look at the current market talk around oil. While just a few weeks ago market chatter was around whether or not it would push lower than $20, much chatter is now focused on whether oil can push through $50 and even $60 per barrel. This rapid change seems to me to be a symptom of sudden euphoria, an irrational exuberance because of the rapid rise in price. As it becomes apparent that prices will not rocket through the 40s, many participants could quickly change their minds.

Why I'm Short Oil

I shorted oil at around $38 per barrel. I believe that prices have risen unsustainably on producer jawboning and profit-taking causing crude markets to head into irrationality around the prospects of future oil prices. I still believe this, and will remain in the short until prices fall below $33 or something causes me to change my analysis on the market.

Disclosure: I am/we are short WTI CRUDE.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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