Player Avatar JakilaTheHun (99.94) Submitted: 4/8/2011 7:17:05 PM : Underperform Start Price: $45.12 USO Score: +13.92

I've expressed my views on oil before, but my general thesis is that at over $120/barrel at Brent, it's unsustainably high. It's in the $120 - $125 range on Brent right now, so I don't think it's necessarily in danger of imminent collapse, but I do believe that long-term gains at this price are extremely limited. Moreover, in the event of a market pullback / crash / double-dip recession, we'll probably see oil fall faster than the broader S&P.

There are several reasons why I don't believe oil can hold up at these levels:

(1) Trucking becomes much less economical vs. rail, meaning that more business shifts to rail, and oil demand is weakened
(2) High oil prices are a drag on the US (and Chinese) economy, which creates a greater possibility for rapid demand destruction
(3) People start to flock to hybrid sedans / coupes with higher oil prices, which weakens overall demand for oil over the long-run
(4) The more expensive oil gets, the more attractive natural gas looks in comparison, causing further potential for oil weakness,
(5) In general, high oil prices stimulate demand for natural gas, nuclear power, and alternative energy, causing further long-term demand destruction for oil,
(6) Likewise, high oil stimulates technological innovation in areas that reduce oil consumption,
(7) Pressure will begin to mount on policymakers to expand mass transit with higher oil
(8) We'll see more oil supply coming from high-cost sources such as the Canadian oil sands

Overall, there are a whole host of factors working to (a) decrease demand for oil and (b) increase supply once prices get this high. Any movement upwards exacerbates these factors exponentially once you tip over the $120 - $130/barrel range.

Overall, I see shorting oil as a good hedge right now and I believe it will underperform the S&P at these levels.

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Member Avatar Valyooo (99.63) Submitted: 4/8/2011 7:51:39 PM
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I am short oil, but how do you see it as a good hedge? If oil goes up the S&P will go down...this is before that causes oil to go down. So if oil goes up more you lose money on the short and your longs get crushed too.

Member Avatar JakilaTheHun (99.94) Submitted: 4/9/2011 11:00:53 AM
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It's a good hedge, because if the economy weakens, oil weakens more. And the economy can only strengthen so much when oil is already above $120/barrel, so the likely of getting obliterated by rising oil prices becomes much lower.

Member Avatar Valyooo (99.63) Submitted: 4/10/2011 1:07:00 PM
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Yeah but by that logic oil could never rise. As has been the case for the last 2 months, when oil spikes up, the market goes lower. So shorting oil will hurt you even as the market goes lower.
I understand what you are saying, but the same should also be true at all prices of oil then. Oil goes up, economy goes down slightly, causing oil to go down more. The price of oil would be unchanging then.
Nothing stopped oil from spiking to $150 a few years back.

Member Avatar Valyooo (99.63) Submitted: 4/10/2011 1:08:26 PM
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Also have you heard of the ETF OIL? Is it equally as bad as USO? Or is USO more broken/effected by contango?

Member Avatar JakilaTheHun (99.94) Submitted: 4/11/2011 11:24:08 PM
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What happened to oil once it went over $140 last time? It plummeted.

You make the connection between rising oil and falling S&P. Actually, that's not normally the case at all. Oil correlates with the S&P better than any other single asset class. There is a breaking point, however, where oil starts to become a major drain on the US economy.

Oil at $120 is fundamentally different than oil at $50. For every incremental price increase beyond that, the demand destruction is magnified. Moreover, the long-term demand curve for oil starts to change the longer it stays at $120 .

On the supply side, there's an abundance of oil that can be extracted profitably at prices over $120/barrel. It takes time for supply to hit the market, but the longer prices stay high, the more supply pushes in.

So I think it's an excellent hedge. The economy's not going to hold up like this if oil pushes above $160. That will create demand destruction for oil, causing it to fall back down again.

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