Oil's Running, How Strong Are It's legs?

By: James Bibbings | Fri, Jun 12, 2009
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This week (June 8-12) I was interviewed by several media sources regarding my thoughts on oil and the direction of gas prices at the pump. These are a few of the questions I was asked and how I responded.

Question: What happened in the last month that's prompted this increase in gas price -- and oil price for that matter?

Response: Over the past month oil prices have moved forward largely as a result of a flailing US Dollar. [The US Dollar Index declined just under 15% since its peak of 89.62 and its 2009 low of 78.33] Besides a weakening dollar, speculation that the Great Recession is nearly over has also turned sentiment on oil. These two factors, almost alone, have created the perfect bullish storm for crude prices. Rising crude costs have of course weighed heavily on prices at the pump.

Summer demand for unleaded gas and diesel is also adding to this run up, but only slightly. According to the EIA gasoline demand is still off 2.9% from this time last year; which was one of the worst driving seasons on record. Fundamentally, global demand for almost all commodities is still weak and this weakness is even more pronounced in the energy/petroleum markets. In fact, regardless of any recent gains, demand for oil is still at a 10 year low.

In response to this weak end user demand, crude refiners have been trying to reduce inventories on hand and have been importing less oil. This is primarily the reason for the Energy Information Administration's bullish inventory report today [Wednesday] which showed crude stockpiles down 4.4 million barrels to 361.6 million; better than the expected 700,000 barrel drop. It is also the reason the American Petroleum Institute reported a large draw on oil inventories Tuesday. So in saying this, it appears to me that overall supply is working itself out of the system, but not because of substantially increased demand or a scarcity of oil. Supply, is working itself out of the system because of low margins at refineries and weak consumer demand; very different from a truly fundamental supply and demand shift. [Later in the week news hit the oil markets of Valero closing a major refining operation in Aruba for this very reason]

Question: Will the two continue to move in tune with each other this summer?

Response: Oil and Gas will almost always move in tune with each other; that is unless there is a bottle neck at refineries. According to the EIA report out today [Wednesday], most refiners are currently operating near 86.5 percent of capacity; far from bottleneck. Since consumer demand doesn't appear to be coming back anytime soon, I don't expect crude oil and pump prices to decouple during the summer.

Question: Many are saying that gasoline is a lot cheaper than it was a year ago. There are also some supposed signs of economic recovery that would imply that demand for fuel will improve this summer...if I'm not mistaken that should contribute to a higher price for oil right?

Response: As I previously mentioned, we are not seeing a true improvement in oil fundamentals. No matter what the government or suppliers try to do or say, consumer demand is still very weak; period. I think it goes without saying that demand is likely to remain low until more people find work. Our now staggering 9.4% and rising unemployment rate strongly affirms this fact. [See my work from yesterday "Believe None Of What You Hear, Half Of What You See"] Consumers without jobs cannot afford gas over $3.00 a gallon, while at the same time refiners and oil producers cannot operate at prices much under $3.00 a gallon. How quickly people forget the record oil profits that were generated when prices were well over $100/barrel and how demand wilted as prices climbed over $3.00/gallon at the pump. Let us also not forget that this was happening when people still had jobs!

Question: If the run up in oil is not fundamentally driven, where are we headed? Is the worst of the economic crisis behind us?

Response: Although the broad markets and media tend to believe the worst of the economic crisis is behind us, I still do not entirely concur. At the risk of sounding foolish later, it is my current feeling that the worst of the crisis will be upon us within the next three to six months. If that is indeed the case, a retracement could drive fuel prices lower or near to where they were in December of 2008. [At that time fuel costs were about $1.65 a gallon nationally.]

To that point, it seems almost incomprehensible to me to consider a significant change in the demand outlook for crude over the near term. Certainly suppliers are trying and will continue to try and tighten up output, but that can only go so far. The more suppliers close up shop, the more they impede much needed cash flows. How can a company, or a country for that matter, service debt with no cash on hand? On top of this it seems that people are trying to look past the fact that the US is the largest consumer of oil in the world. So again, with ongoing unemployment claims rising, our unemployment rate climbing, and a geopolitical agenda that is pushing the world towards greener technology, where will increased discretionary income or demand come from in the near term?

Question: What will lead us to recovery then?

Response: We need to remove all bad corporate and personal debts from our financial system. We cannot continue to bail companies and individuals out forever. Around the world, not just within the US, the "save the economy" spending spree will have to eventually stop. At that time we must allow the system to reset itself through personal and corporate bankruptcies. As we now know through Lehman Brothers, GM, Chrysler, Indymac, and others, the world will not end if "too big to fail's" fail and declare bankruptcy. The United States lived beyond its means for far too long and is now suffering the consequences of this lifestyle. So again, our debts need to be washed clean from the financial system before we fully recover and I don't believe that has occurred yet. [Karl Denninger touched on this during the week, check it out]

Question: Any final thoughts on crude? Where will it be trading between now and the end of the month?

Response: As of now crude oil is starting to look a bit overbought and may be set for a pull back. This pull back should be even more pronounced if the US dollar is able to hold its footing. Over the past week the Dollar has hit technical support at USD Index 78.00 and has held. This, along with weak underlying fundamentals for oil, suggests to me that crude may be ready to turn between now and July. Until that turn, I expect pump prices to hold between $2.45 and $2.65 nationally assuming no more major refineries go offline. However, around mid summer to early fall I expect to see oil trade between $40 and $55 per barrel with pump prices coming in line. At that time I would expect them to start stepping down towards levels not seen since December of 2008. [For a more detailed discussion of my long term forecasts see "Oil at $25 a Barrel? Gas $1.50? The Time Is Coming Soon"]

All the best for your weekend.



James Bibbings

Author: James Bibbings

James Bibbings

James Bibbings

James Bibbings is an associate editor at Commodity News Center ("CNC"), a website which focuses on providing the latest commodity news and analysis. In addition to this Bibbings is also the president of Hugo James Consulting; a firm which specializes in offering compliance solutions to the brokerage industry. Mr. Bibbings writes daily as the "Economic Bibb" for Commodity News Center and through his writings strives to provide a unique outlook on the economy, the financial markets, and the global political landscape. It is his intention to add variety and insightful information to what he feels is an "over informed, yet "under educated" populace.

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