Why Oil Prices Will Breakout - The Demand Driver

by: Markos Kaminis

I see oil prices breaking out of their recent trading range.

The supply side question has been the focus of most investors, but I'm looking elsewhere for a surprising catalyst the market has mostly overlooked.

I expect robustly improving economies in the U.S., Europe and China to significantly raise demand for energy and to balance the energy market faster.

Despite oil's most recent gains, I still see plenty of upside for oil prices. In fact, I see oil breaking out of its recent trading range and marking new highs through its current run. Many are looking to supply side efforts to bring market balance, or not, but I see a different driver making an important difference. Demand for oil should improve markedly as global economies move into a higher growth phase.

For relevant reasons, the focus of oil market enthusiasts has been completely on the supply side of the equation. Increasing production in the U.S., Libya, Nigeria, Iraq and Iran has fed into a market stuck in a supply glut. OPEC and non-OPEC producers are attempting to address the supply side issue, effectively I believe too, but demand gains should help to set the market into balance faster than expected.

U.S. GDP growth was just reported at 2.6% for the second quarter. Moving forward, I expect even better growth to come. The labor market is operating now at full employment. The longer people are employed, the more spending we are likely to see, including for higher ticket items.

This week, Pending Home Sales showed a 1.5% increase in contract signings for existing homes. Later this week, the annual pace of auto sales is expected to increase. It's my opinion, that economic data will increasingly reflect a step-up for the U.S. economy, mostly due to the improved employment situation and resulting spending but also on other drivers.

Certain initiatives by the new Administration should help to make spending more fluid. The Trump Administration has been actively working to reduce regulation and red tape. Banks are being freed to lend, especially since overcoming the federal capital constraint burdens that followed the "too big to fail lesson" of our recent past. I strongly believe tax reform is coming to America, and that it will invigorate consumer spending as well.

The oil market is global in nature, but thankfully, economic gains are global as well. China just reported stronger than expected GDP growth of 6.9%, causing economists to raise their expectations for the emerging giant. Today, the Caixin China General Manufacturing PMI for July improved to a four-month high. New orders was at its highest level in five months, supported by export growth.

Eurozone PMI showed growth across all of the covered nations, including Greece. GDP data for various eurozone nations has been positive as well, and today eurozone GDP was reported accelerated to 2.1% year-on-year in Q2, up from 1.9% in Q1.

Global economic growth means upward adjustment to demand for energy, and OPEC just indicated it was seeing as much. OPEC adjusted its demand expectations upward in St. Petersburg, and indicated that improved demand would offset the increasing production of Libya and Nigeria. The International Energy Agency (IEA) also recently increased its global demand forecast via its monthly Oil Market Report. I expect these upward adjustments to demand to continue, and to serve to more quickly solve the oil market glut problem.

Security 07-31-17
United States Oil ((NYSEARCA:USO)) +1.1%
iPath S&P GSCI Oil (NYSE: OIL) +1.9%
Energy Select Sector SPDR (NYSE: XLE) +0.2%
SPDR S&P Oil & Gas E&P (NYSE: XOP) -1.0%
Exxon Mobil (NYSE: XOM) +0.6%
Chevron (NYSE: CVX) +1.0%
ConocoPhillips (NYSE: COP) +0.2%
Marathon Oil (NYSE: MRO) -1.1%
Pioneer Natural Resources (NYSE: PXD) +1.1%

In conclusion, one critical catalyst oil traders have not been adequately factoring into the supply/demand balance equation is improving demand. Economies are expanding more robustly globally now, and demand for oil must increase as a result. Oil prices will breakout, partly because of this factor. This report is part of a several part series. To receive the next part and all my regular work on energy and markets, readers are welcome to follow the column here at Seeking Alpha.

Disclosure: I am/we are long USO.

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.

Additional disclosure: My position is via options.