Sunday, June 08, 2008

Crude Oil Update

Despite the huge run up for crude oil prices - seen in the last ten years (up more then 1000%) there is no sign that the long term top is in. looking at the long term linear and logarithmic charts below you can see that higher highs are certainly possible.

Crude oil long term linear chart

Crude oil long term logarithmic chart

Obviously anything that goes up can go down but the crude oil market enjoys an ever increasing demand , low above ground inventories / consumption ratio and 100's of millions of consumers that are willing to pay increasing prices at the pump. Currently there are no major reports of immediate oil shortage, the price seems to be the major factor which keeps the supply demand balance in check.


John said...

You know I think the oil top must be close at hand, I say this because fundamentals no longer seem to apply. There are a few things that drive the oil market up: demand/supply and the lack of exploration/development from 1985-2000 (due to price) and of course monetary policy.

But at the same time, when you compare the btu/dollar you get, other energy prices should be much higher if you think oil is at a fair price, or oil should be much lower. Natural gas is a good example, using the current price of oil it should be priced at ~21 dollars, if you do a side by side btu to price comparision.

Perhaps it will hit 150 and pivot. If I were speaking from a chartist point of view I think you might have missed several solid points of entry, and could very well get whipsawed every which way if you tried to enter now.

I think this though the dollar strength is critical, look at charts of oil in euros and you'll see that you're really missing the spike upwards. So the dollar strength (or lack thereof) is clearly having some impact.

Any thoughts on agriculture?

troy said...

Hi John!

I have to disagree about oil not going up in euros. for the same time frame..Oil is up from 8.8 euro@ 1999 to about 90 euro 2008 - thats is 900% !!! a long term top in oil ? - I think not yet , could see even more upside volatility and demand spiking down.

The Ags are skyrocketing as well ....

John said...

Check that out, I realize it's not recent, but it illustrates the point well enough. If you had converted dollars to euros to buy your oil, you would have saved a bundle.

Understandably oil went up in euros too since the currency is not a hard backed or commodity backed currency, but it hasn't risen as sharply as it has in dollars. That was my point.

As for the demand? it's hard to say; there are traders sitting in contracts from 7 years ago rolling forward without delivery... does that constitute demand? I think there is certainly increased consumption (that goes without saying).

I just see a large discrepancy between the btu/dollar for oil and other energies and it doesn't make sense. Furthermore the more the price rises, the more affordable alternate extractions methods become and yet they don't seem to fully exploited (like tar sands or shale extraction, or visiting older fields that were dumped because of their production costs).

I think the ceiling is close at hand. But we shall see, one day at a time.

I do think the big winners will be refineries when the price starts to come down.

troy said...

Hi john!

I'm truly an ignorant about Btu calculations.

I can see that $wtic:$natgas ratio was between 2.60 and 14.51 (1995 – 2008) currently about 9.7.

Anonymous said...

What a cool picture. It looks like an ongoing impulse.

John said...

Perhaps this is pertinent in explaining the rapid drop.

An exerpt of the article by ADAM HAMILTON:

With an oil correction long overdue for sentiment, technical, and upleg-correction-cycle-precedent reasons, it certainly makes sense for traders to game this high-probability eventuality. Thanks to the surge in innovative ETF-type trading vehicles, there are many ways for stock traders to bet on an oil correction today. We have been discussing these, and launching trades in them, in our monthly and weekly newsletters lately.

Provocatively, the growth in ETFs could be another factor amplifying correction 10 beyond the magnitude of its predecessors. The primary long-side oil ETF trading in the US today is the United States Oil Fund. USO launched back in spring 2006, and it took some time to grow popular. So the mighty 165% upleg 10 was the first oil upleg to emerge in this new era where stock traders were comfortable buying USO as a long-oil proxy.

In order for any ETF to actively track its underlying asset, there has to be a mechanism for supply/demand differentials in the ETF to be transferred to the asset. For instance, if stock traders bid up USO much faster than oil itself is rising, the ETF threatens to decouple to the upside and fail its tracking mission. So USO's custodians shunt this excess demand into oil to maintain tracking.

This is accomplished by issuing more shares. The new shares help to absorb the excessive demand in the ETF relative to the asset, slowing its disproportional ascent. With the cash raised from issuing these shares, the ETF's custodians buy more oil futures. So demand for actual oil increases too which helps close the gap between the ETF and the asset. Excessive stock buying pressure flows through the ETF to ultimately bid up oil futures. All ETFs work this way to stabilize demand differentials and ensure tracking.

But effectively giving indirect access to futures markets for stock traders' vast pools of capital is a double-edged sword. If falling oil prices scare stock traders more than futures traders, USO could start plunging faster than oil and threaten to decouple to the downside. Its custodians would be forced to react to maintain tracking. They will buy back ETF shares to soak up excess USO supply. And they'll raise the cash for these purchases by selling their oil futures.

This effectively shunts excess USO selling directly into the oil market, amplifying any downside that scares stock traders into selling faster than futures traders. The point of this digression is that the 10th oil correction could be pretty severe if stock traders get scared and start aggressively selling USO. Flight capital out of long-oil ETFs will exacerbate normal futures selling and accelerate

any major decline.

John said...


I think we're seeing this happening accross most of the futures boards, as the smaller investors rushed into these ETF's and funds, it provided a great opportunity for the bigger players in the game to dump their holdings to a 3rd party, which puts the real loss in the publics hands. Since the funds (ETF's/common stock) operate very mechanically you can see how they would have bought up massive amounts of contracts to keep pace, and then a large price fluctuation could force sales irrespective of the market demand "because an algorithm indicates the ETFs must sell" in order to successfully track the market.

Since the ETF's and tracking stocks are priced two ways 1) by the connection to the futures markets BOD and EOD, and 2) intraday trading ACC/DIST. You may not even know you got smoked or made a bundle until the following day!


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