Why Oil Prices Fell - Buy The Dip

by: Markos Kaminis


Oil prices fell precipitously on Tuesday, though after a period of significant appreciation.

Some profit-taking and/or short speculation likely played a role.

The failure of the U.S. to sanction Venezuela's oil industry also let some bets on as much down.

The American Petroleum Institute (API) reported a surprise build in crude oil inventory, though traders ignored a significant draw when including petroleum products.

Oil prices have good reason to mark a violent upside reversal, for various short-term and long-term reasons.

The price of oil plummeted on Tuesday for a few reasons. First, oil prices had come a long way fast, and were susceptible to profit-taking and short speculation. Second, the failure of the United States to penalize Venezuela's oil industry for the evils of its government were a letdown to some who had bet on it. Third, the American Petroleum Institute (API) published a less than perfect bullish report on weekly inventory. But, beware oh ye of little faith, for your fear is premature. Oil has good reason to rise further, and may find some more reason as soon as this morning.

Security 08-01-17
United States Oil (NYSEARCA:USO) -1.9%
iPath S&P GSCI Oil (NYSE: OIL) -3.0%
Energy Select Sector SPDR (NYSE: XLE) -0.02%
SPDR S&P Oil & Gas E&P (NYSE: XOP) -0.7%
Exxon Mobil (NYSE: XOM) +0.2%
Chevron (NYSE: CVX) +1.5%
ConocoPhillips (NYSE: COP) -1.4%
Phillips 66 (NYSE: PSX) +2.2%
Rice Energy (NYSE: RICE) +0.3%
Pioneer Natural Resources (NYSE: PXD) +0.1%
Cabot Oil & Gas (NYSE: COG) +2.0%
EOG Resources (NYSE: EOG) -0.7%

Crude oil prices dropped dramatically on Tuesday, especially for those who lacked the perspective of the last several weeks worth of gains.

USO Chart 1 Month at August 1 2017 USO Chart 1-Month at August 1, 2017

So perhaps some profit-taking took place as antsy holders of energy bets looked ahead to data that might undermine their tentative stakes. Perhaps, also, some speculative bets were made to the short side, though I believe short-sighted.

There were a couple reasons applicable to the sellers' argument though yesterday. First, there had been some speculation that the United States might sanction Venezuela's oil industry in order to penalize its government for seizing power via questionable votes and alterations to the country's constitution. Basically, Venezuela is enabling its leader, under the guidance of its leader, to undermine its democracy. Whether that is something new or old for Venezuela is up to others to debate. What we're considering here is the ramifications to the energy sector.

When the United States' initial sanctions turned out to be focused on its leader, and did not include any penalty to the oil sector, that definitely had an impact on oil to some degree. We saw oil prices spike the day before on I believe an increase in long bets on the Venezuela factor. Thus, when that factor failed, those bets came off. Perhaps some momentum built upon that as well.

Secondarily, oil likely needs further fundamental support here at the psychologically significant $50 mark. Concern about this week's inventory data probably started to weigh against the commodity ahead of it. When the American Petroleum Institute (API) reported a build in oil inventory late in the day, oil took another leg lower.

According to sources, API reported a surprise build in crude oil inventory of 1.8 million barrels a day last week. Builds are bad for a market dealing with a supply glut. But traders ignored the fact that API also reported a large 4.8 million barrel draw from gasoline inventory and a 1.2 million barrel draw from distillates inventory. Thus, on net, including petroleum products, there was a significant draw from inventory reported.

The negative bias of this market is apparent here, because when the data falls the other way on net, with a net build in oil and products, despite a draw from crude, oil prices typically fall. This time, with the scenario reversed, prices still fell.

Something like this has to correct eventually, as smart money accounts for reality. Perhaps we'll get a dose of reality this morning, when the Energy Information Administration (EIA) reports its more widely followed and trusted inventory data.

If there is a significant draw from crude and petroleum products, I expect a violent reversal of yesterday's decline in oil prices. Also, with the arrests yesterday of all the serious opposition leaders in Venezuela, you can expect more sanctions from the United States. Whether that means sanctions applied to the critical oil industry is uncertain, but it remains possible. I may explore this topic in a future report, and how it might impact oil prices. I think it is clear, though, that oil prices would spike higher significantly depending on the degree of stifling the U.S. might apply to Venezuela's industry.

In conclusion, it's important investors realize there are good reasons for oil's recovery from trough. Namely and first among all, global economic gains, which I discussed yesterday, and how they should impact the demand side of the equation. The oil supply side problem might be quickly resolved if the economic gains seen recently in Europe, China and the U.S. continue and/or accelerate, as I expect. Also, I believe OPEC is dealing with the supply side effectively. There are several other reasons for oil prices to breakout from the recent range of $40 to $60, which I will be discussing in my series on the topic. Readers may receive those reports along with all my work on energy and markets via 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.