Thursday, March 12, 2009

Crude Oil -- The Bull Clique Returns

I put Monday morning's newsletter up on Market Oracle. the subject was the Oil market. you can read the article by clicking here.

since I've just been an obscure blogger, who has just recently started putting promotional material on a well-trafficked site like Market Oracle, I'm not used to getting much feedback on my work. but some of the responses to this Oil article have been interesting. and there's one I got this morning that I probably need to respond to. the reader's comments are in italicized block quotes. my responses are in normal font.

Interesting article but I lean more toward the T. Boone Pickens forecast of higher oil prices by the end of 2009, not lower. I am a bit more conservative however, thinking a range of $60-70 is more probable; Boone favors $75-80 by the end of the year. Let's consider the following:

1. Oil producers will always have the capability to cut production more than "demand can be destroyed". However, I must admit this is no normal recession, although US gasoline demand actually rose 2.2% over the past month, which is encouraging. Taking the oil sands in Canada for example. Suncor Energy and others are simply slashing CAPEX projects until oil gets back above $65. End of discussion. Those cuts alone are removing daily oil production on the order of 500k bbls per day.

for the sake of argument, let us assume that the assertion made in the first sentence of point 1 is true. just because the producers have the capability to cut production it does not follow that they have the (collective) Will to do so. and even if a meaningful cut in global production is achieved, the previous supply overhang must be dealt with also. and in fact I believe that the market is dealing with that issue just fine at the moment.

regarding your price target of $60 to $70, I should point out that I am not predicting that the price won't go up to that level at some point this year. In the article I did write, "I respect the possibility of a good suckers' rally before the next wave of price destruction ensues."

then on the long-term chart of the December contract I included a few horizontal lines that I considered reasonable retracement targets to look for prior to the 'next wave of price destruction.' but reviewing my report I see that I neglected to explain those targets in words. looking at those lines again here I notice that those horizontal lines are clustered at the 60 to 70 Dollar range.

that retracement area was just a fuzzy guess, but there might be something to it. my projection is not that the market won't go up to that level, but that the level will not hold. this outlook is predicated on the understanding that commodities - and Oil in particular - have been in a 'bubble'. if this view is correct then my theory of asset bubbles that I have been developing indicates that this bubble has not fully deflated. I will more fully present this theory to the public later on, but for those interested, you can read my very initial thoughts on the subject in another report I had published at Market Oracle last month. (click here.)

The timing of the market is not something that I have any certainty at all about. when I started predicting a bear market in Oil last year I was a little early.

Monday, May 12, 2008
Oil's About Done...Maybe

...but I kept watching it and by later in the summer my conviction was pretty strong.

Wednesday, July 30, 2008
Norwegian Krone Update

readers may want to review those two posts. I don't consider either one to be especially brilliant, and really nothing in particular I do is brilliant, but they do give you an idea of the style of analysis I am prone to. I suppose you could call it more 'imagination-based' than 'fact-based'.

2. Shockingly, the latest oil production report out of Mexico's largest oil field (Cantarell) shows much worse decline rates than estimated. In fact if things are not reversed Mexico is in danger of becoming a net IMPORTER of oil by 2013. FACT: Mexico is currently the 3rd largest exporter of oil to the US. The news isn't any better out of Russia, the North Sea, or Alaska, where major declines are occurring. Brazil has discovered a new promising field in deep water but how viable do you think deep sea exploration/production will be at $40 oil? ANSWER: Not very.

great! but all these Facts bear no relevance whether the price of December Nymex Crude will fall to 30 bucks later this year. I just don't see the connection.

3. Much of the oil price decline has been driven by two factors (neither of which has anything to do with lower oil demand); surprising strength of the US dollar (USD) and unwinding of speculative positions by hedge funds. These latter two causes are about to "dry up" as the USD reaches a classic "double top" within a long-term secular decline and hedge funds conclude their "unwinding" process. Add in the start of summer driving season and you have a classic recipe for higher oil prices. OPEC cuts do not hurt either as they remove unneeded oil from the market. OPEC complance with their cuts is above 80%, noted to be the highest compliance rate ever.

or how about this instead: "much of the oil price rise was driven by two factors (neither of which has anything to do with lower oil supply); surprising weakness of the US Dollar (USD) and the building of speculative positions by hedge funds."

so I guess my point is that if you are implying the deflation now is somehow artificial, then it is just as logical to view the previous inflation as the same. which raises a question, if there was no 'real' basis for the inflation, then why should we now think that Oil now at $40 or $50 is somehow 'cheap'?

this is just a rhetorical point I'm making. the specific issues are whether the Big UnWind is over and whether the Dollar is due to slide lower for the remainder of eternity.

my current view is that the Big UnWind has not ended. there are a host of hunches underlying this view, but I don't have time to go through them all now. but I admit that this is something I could be wrong about. and since I don't have much of an agenda I reserve the liberty to extend and revise my remarks.

when I spotted the 'orthodox deflationary environment' on the horizon last summer I initially figured it would be in force till about the end of the year.

then in November I predicted that the S&P 500 would hit 666 this year:

Saturday, November 8, 2008
666 - S&P 500 and the 13 Year Cycle

but as the index made its approach to that number, I came to the conclusion that my wave count was off. I do not think that the decline from the beginning of the year to earlier this month was final leg or '5th Wave' decline of the bear market. I believe the current rally is the Wave 4 counter-trend move to be followed by Wave 5 culmination, though I see some possiblility that the 5th Wave will be non-confirming. the index might hold 666 or 700 in other words.

so you see that my outlooks evolve as circumstances develop. my vision for the Dollar though has changed little since I outlined the scenario you can read in the following two posts:

Monday, September 15, 2008
Gold and the Dollar -- an Historical Comparison

Wednesday, October 15, 2008
Gold and Dollar -- Historical Comparison Update

so you say the Dollar is making a 'double top'. I am more inclined to view this as a bullish flat. to each his own. vamos a ver.

also I do not think that there is a one-way correlation between currency exchange rates and commodities prices. in fact my analysis has recently started to focus on the relative values of different commodities and how a structural shift in those relative values have the potential to affect the foreign exchange markets. I've alluded to this before, but in the latest daily newsletters I am firming up the theory.

4. Continual reports by the EIA, IEA, IMF, and the other "alphabet soup" of prognosticators are busily revising their weekly forecasts of global oil demand lower and lower. There is only problem with this scenario. THEIR FORECASTS ARE WORTHLESS!!! No one knows what oil demand will be in 2009, 2010, or even 2015 for that matter. Not OPEC. Not the IMF or any of the other world bodies. It will depend on future pricing, the speed of recovery in the global economy, geopolitical factors, and other issues beyond the control of these agencies. So if you are an oil trader "shorting" oil because of these demand forecasts you are an idiot.

I don't recall ever reading anything about Oil from any of the acronymic entities you mention. I don't read much at all frankly. guys like Ortega y Gasset and J.B. Say I like to revisit on occasion, but I spend most of my time smoking cigarettes and flipping through my chart books. Data First! thank you very much.

For the record, I'm not shorting Oil (or recommending that my clients short Oil) right now.

Anyway, these are just some of my observations. The oil market is and will remain volatile. But there is no doubt that supply destruction is occurring at a more rapid rate than demand destruction. And 6 billion Chinese and India residents will not be foresaking their automobiles for bicycles anytime soon.

Good luck.

C. M.

thank you for the letter, sir. check back here on occasion for updates on my outlook. as I mentioned, my views are subject to change as the evidence changes. but I am more prone to consider factors such as market structure than assertions that the supply of petroleum just has to be drying up.