Crude Oil Consolidating Before the Next Big Move Higher

By: Sean_Brodrick

As I recently pointed out on my blog (“The Dollar and Oil”), oil and oil stocks in particular are underperforming the market rally. We have seen inventory builds in the U.S., including a big build this week, but there are many other forces that should be bullish for oil prices, even in the short-term. Here are just some recent examples …

• Iran Oil Minister Masoud Mir-Kazemi says OPEC won’t raise production when it meets in Luanda, Angola, on December 22 to review output targets and the impact of supply reductions announced last year. Ministers from Kuwait and Nigeria have also indicated they expect quotas to be left unchanged.
• The purchasing managers’ index for China, released today by HSBC Holdings, rose to a seasonally adjusted 55.7 from 55.4, the fastest pace in five years. Combined with other indicators, this points to Chinese oil demand increasing by 5% this year and at least 4% next year. A U.S.-bound supertanker was seized by pirates off Somalia. This potentially impacts U.S. supply.

This is just the news out recently. So why isn’t oil higher? I think someone with big pockets is selling every time the price of oil goes up. It could be a big trading house like Goldman Sachs — the “vampire squid” of the American economy, as Matt Taibbi called it in his now landmark Rolling Stone article.

I’d rather not be on the other side of their trades, for the simple reason that they have tools and access the rest of us don’t — like High Frequency Trading (which I believe should be illegal) that allows them to push markets around in rather shifty ways. But it’s not just Goldman Sachs — there are multiple vampire squids who can manipulate the markets; they have very deep pockets.

When it comes down to it, I’d rather not wrestle a vampire squid at all. I’d rather be the guy sitting on the dock drinking a beer, cheering on some other poor sap who is splashing around and wrestling the squid: “Dude, you’ve totally got him! Keep at it! You’re doing great!” But sometimes you get to sit on the dock, and sometimes it’s your fate to wrestle the squid.

Let me put my tin-foil hat on and say if a big-pocketed vampire squid decided to make money off a lot of small investors, they might do something like we saw last week — breaking news about the Dubai crisis came on a day when markets in the U.S. were closed — another very suspicious thing, as if someone was trying to push the oil market around.

Now, let’s take the tin foil hats off and say there could be many other things causing the oil market to gyrate. I’m just laying out one scenario here. And why would a big trading house try to manipulate the oil market, anyway? Well, there are some really bullish longer-term forces for oil …

India’s Economy Is Ramping Up. India’s economic growth surged in the third quarter. Gross domestic product grew 7.9% from a year earlier, accelerating from a 6.1% expansion in the previous quarter and marking the fastest growth since the January-March quarter of 2008. Activity at India’s factories and mines has been firing on all cylinders as fiscal stimulus lifts demand for automobiles, steel and cement. Result: India is using more oil. India’s oil product sales rose 17.3% in October from a year earlier, the country’s Oil Ministry said last week. India’s oil demand is expected to rise 3.9% year-over-year going forward, according to the International Energy Agency (IEA) estimates.

China’s Economy Has a Ravenous Thirst for Oil. China’s GDP rose 8.9% in the third quarter from a year earlier, accelerating from 7.9% in the second quarter and 6.1% in the first quarter. Result of all this economic activity: China’s oil demand rose 10.3% in October, and is expected to rise 3.5% annually going forward.

Production in Mexico Keeps Falling. Mexico’s oil output may “decline sharply” next year as state-owned Pemex enters a sixth year of falling production. According to data projections from Barclays and Bloomberg, Mexico’s output may drop 8.9% in 2010 from this year. That’s a drop of about 233,000 barrels each and every day. This is potentially a big problem for the U.S. In September, Mexico was our #2 supplier of imported oil, providing 1,938,000 barrels per day. Imagine if 12% of that supply disappears — which it will.

Estimates of Global Oil Demand Are Rising. With China, India and other emerging markets putting the pedal to the metal on oil consumption, the IEA raised its oil-demand forecast, saying global oil consumption is likely to average 86.2 million barrels a day next year, 140,000 barrels more than the IEA estimated last month. The IEA also increased its forecast for consumption this year to 84.9 million barrels a day, up 220,000 barrels from October. And OPEC also raised its estimate for 2010 global oil demand, saying growth should rise by 750,000 barrels per day.

Seasonality Is in Oil’s Favor. Prices for oil typically find a bottom in December through February. And technically speaking, the set-up in crude oil may be following a previous pattern of consolidation before a big move higher …

If oil can move convincingly back above $80 a barrel — which has proven to be strong overhead resistance — my forecast is that prices could be poised to reach $90 or even $103 a barrel in the next six months if oil maintains the rebound from the beginning of this year.

The U.S. Is Going Bankrupt and the Dollar Will Continue to Sink. This is actually grist for another whole column, but I’ll just point out the obvious: Within the next 12 months, the U.S. Treasury will have to refinance $2 trillion in short-term debt. Additional deficit spending should total $1.5 trillion. So, we have to finance $3.5 trillion in total over the next year, about 30% of GDP. Who the heck is going to buy all that debt? I think the only way to finance it is to print money (much of it is “printed” electronically, but the principle is the same). And that should sink the dollar. Since oil is priced in dollars, as the dollar slumps, oil should go much higher.

So to come back to the question, why would a vampire squid of a trading house manipulate the price of oil? Because oil demand is ramping up in the emerging markets, OPEC is content to sit on its hands, and money is probably going to start rotating into the energy sector early in 2010. So of course, the smart money would like to buy oil cheaper by driving the price down in the short term.

And here’s the thing: A big trading house is usually smart enough to close out its trade when it makes enough money. But if they get cocky, their bets can go spectacularly wrong — which means your bet can go spectacularly right.

Caution Is Warranted

To be sure, not everything is bullish for oil. We did see a big inventory build this week — a rise of 2.1 million barrels, according to the EIA. OPEC worries that higher prices will weigh on global demand. If the global economy goes into a ditch again, that would weigh heavily on oil demand. And in the last two years, U.S. oil consumption has fallen 9%, down nearly 2 million barrels per day (mbpd) to about 18.8 mbpd in October 2009. On the other hand, U.S. demand is rising again — the EIA, in its November Short Term Energy Outlook, sees U.S. oil consumption recovering 1.4% to 19 mbpd on average in 2010.

Also, think about the supply side. Mexico isn’t the only problem. Most of the major oil producing countries have hit peak production. And a year’s worth of deep-water projects were delayed or canceled when oil prices tanked in 2008. According to the IEA, global investment in oil and gas production has slumped 19% this year compared with 2008 — a cut worth $90 billion! That implies a major squeeze in supply down the road.

Two Ways to Play This

You can play this move with exchange-traded funds. The United States Oil Fund (USO) generally tracks the trend in crude oil. And the ProShares Ultra Oil & Gas Fund (DIG) is a leveraged fund that tracks a bunch of energy stocks that are themselves leveraged to the price of oil. If you agree with me that oil is going higher, either fund would offer opportunity. Full disclosure: My Red-Hot Commodity ETFs portfolio is already long the USO.

Yours for trading profits,

Sean

P.S. Remember to check out my daily updates at http://blogs.uncommonwisdomdaily.com/red-hot-energy-and-gold/.

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