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Oil wants to drop and there’s no stopping it…for now



May 30, 2008 – Comments (6)

Just as oil shrugged off any piece of bearish news like a bullets bouncing off of Superman’s chest on its parabolic rise, yesterday it ignored a surprising piece of bullish news that came out.  In this week’s oil inventory report, the Energy Department reported that the United States’ crude oil inventory fell by 8.8 million barrels when most analysts expected it to rise.  To put this statistic into perspective, this is the largest drop in oil stocks since September 2004.  So much for that demand destruction that we have been hearing so much about.  Our oil inventory is now more than 20 million barrels below its historical average level.

The market’s muted reaction to this surprising piece of data, which normally would have caused prices to surge, leads me to believe that the bears have the con right now and that we probably are in the middle of a short-term correction in the price of oil.  Where will we land?  It is very difficult to say.  I have been blogging that I would not be surprised if we saw oil pull back to the $115 to $120 area.  The mumbo, jumbo, hocus, pocus chart analysts on TV have checked their candlesticks and ouija boards and say that $120 is a technically important support level.  I suppose that sounds reasonable to me, but I don’t really care.  The long term story and the reason why I have been purchasing E&P, driller, oil services, etc… stocks is very much in tact.

The amount of this finite resource that emerging markets use is rising dramatically.  The percentage of people in the world who live on a dollar per day has fallen from 40% in 1981 to 18% in 2004 and it is estimated that it will fall to only 12% by the year 2015.  During the period from 2000 through 2007, income per person around the world rose at 3.2%, the fastest rate ever recorded.  Emerging markets now account for approximately 40% of the world’s economy when measured by purchasing power parity. 

And these countries still have a lot of room to grow.  China’s per capita GDP is currently only $2,500.  It can easily double this figure to $5,000 in a few years.  The same is true for India.  So what you say, that’s still way less than the per capita GDP in the U.S.  Well, try multiplying it by the 2.5 BILLION people who live in these two countries.  That doesn’t even take into account the surging economies in countries like Brazil or the Middle East. 

The bottom line is that everyone outside of the United States is earning much more than they have in the past and this trend is likely to continue.  As these people earn more money, they will buy things that either consume or are made from of oil.  All this is happening at the same time that the world’s major oil producing countries have underinvested in infrastructure and production from some of the largest oil fields is peaking.  To me, all of this points to higher prices over the long-term, regardless of what short-term pull back we experience.


6 Comments – Post Your Own

#1) On May 30, 2008 at 9:21 AM, WillSurfForFood (61.79) wrote:

Hey Deej,

I'm as bullish long term on oil as you but that report by the department of energy makes be doubt those numbers are meaningful. Didn't the department of transport just report the largest drop in miles driven recently? I'm seeing people pay more attention to miles driven around me. There seems to be evidence of demand destruction in the US. Not world wide because  86 million barrels of oil and equivalentnts are still produced and used each day. Perhaps we imported a little less. Good blog as usual.

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#2) On May 30, 2008 at 10:41 AM, TMFDeej (97.46) wrote:

Thanks willsurf.  It's difficult to say why we are getting conflicting reports.  You're right about people seeming to be driving less.  If that is indeed the case, it may mean that for some reason we imported less oil or perhaps that refiners are finally cranking up their operations again now that crack spreads are a little more reasonable.  Either way, this news should have been bullish for the price of oil and the bears shrugged it right off.  It will be interesting to see where the price heads for the rest of the year.


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#3) On May 30, 2008 at 11:04 AM, saunafool (< 20) wrote:


I've taken a look at the relationship between inventories and price in the past and found absolutely no correlation! That's right, I took the 30 years or so of data from the DOE website and looked at high and low inventory levels compared to oil prices and the numbers basically end up being meaningless.

Here's my explanation of why: At 300 million barrels, the total inventory is only about 15 days of consumption. Even though current levels are down historically by about 20 million barrels, that only amounts to 1 day of supply.

Considering how much the traders look at that number every week, I find it rather insane that almost no one points this out. When I looked at the numbers, my conclusion was that any variation between 250 million and 350 million is purely random, normal, and totally unrelated to price.

Outside of that range, I only suspect inventories matter if they are in a consistent trend, combined with other events. If our inventory was showing a consistent decline over several months while Mexican exports to the U.S. were also falling, for example...

All the same, the traders look at the inventory numbers because they think that by looking at the same thing as everyone else they will be able to guess where the market is going. Being that they didn't bid the price up on a surprise decline does indicate they aren't too eager to pay $130/bbl.

I hope oil drops down to $80/bbl again and the oil patch gets crushed. I'll have a chance to buy more.


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#4) On May 30, 2008 at 12:22 PM, XMFSinchiruna (26.55) wrote:

I agree oil is set to correct and then consolidate before moving higher.  This particluar consolidation could last a while, and I wouldn't be surprised to see range-bound trading between $110-$120 for a while, but after consolidating it will take out $150 by year's end, IMO.

Of course, the trajectory of oil is far less predictable than many other commodities.  The meddling of Congress, the potential for OPEC to discontinue the USD oil bourse, etc... any headline any day could change everything.  For that reason, I would hold onto some oil exposure no matter what... but there's no shame in reducing exposures a tad at this stage.

Meanwhile, there's always natural gas and coal. :)

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#5) On May 30, 2008 at 1:41 PM, TMFDeej (97.46) wrote:

Thanks for the comments guys.  I'm not selling a drop of oil.  I'm in this for the long run, though I have consolidated my positions by selling a few of my smaller positions and buying more of my two favorites.


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#6) On May 30, 2008 at 1:41 PM, TMFDeej (97.46) wrote:

Thanks for the comments guys.  I'm not selling a drop of oil.  I'm in this for the long run, though I have consolidated my positions by selling a few of my smaller positions and buying more of my two favorites.


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