Another Moon Shot For “Texas Tea”?

| April 7, 2010 | 0 Comments

Just last week I was writing about crude oil.

I talked about the importance of crude for world economies.  We also talked about peak oil theory and its affect on oil prices.

Now obviously, there are other important factors affecting oil prices besides “peak oil” theory.  Current supply/demand figures, along with economic growth rates (GDP), play a big part.  And we can’t forget the value of the U.S. Dollar and geopolitical issues.

So let’s take a quick look at the fundamentals for crude oil…

Currently, oil is around $86 a barrel.  This is a whopping 145% rise from the lows created during the financial crisis in 2008.  Compare this to the S&P 500 which is currently up around 78% in the same time frame.

Now, let’s assume these two markets are accurate reflections of economic conditions.  Using these numbers, it’s safe to say crude oil is leading the economic recovery by a long shot.

But the real condition of the economy says prices should be much lower…

First of all, unemployment figures are at a stubbornly high 9.7%.  With millions of people still out of work, demand for oil and gasoline is relatively low.  Proof of this is found in Energy Information Administration (EIA) numbers.

According to a recent EIA report, oil refiners have “significant excess refining capacity”.  In layman’s terms, this means demand for gasoline is very low.  So low in fact they are shutting down oil refineries.  That’s right, oil refiners are either idling plants or operating at rates well below full capacity.

We can also see from the EIA, inventories for crude oil have been building for nine weeks straight.  This means the amount of oil in storage for U.S. consumption has been rising.

Also, the Organization of Petroleum Exporting Countries (OPEC) recently announced it has nearly six million barrels per day of spare capacity.  This means millions of barrels of production could be quickly added to the markets.  All they have to do is turn on the tap…

With these bearish fundamentals, the price of oil should be much lower.  I think a reasonable price for oil is around $60-$65 a barrel, especially given the current economic conditions.

Yet, the markets say otherwise…

Crude prices have risen 18% in the past two months.  All while U.S. crude supplies are growing.  These supply levels should be keeping a lid on oil prices.  But they’re not…

As you can see, oil recently broke out of a trading range between $70 and $82 a barrel.  The green line shows a clear long term uptrend for oil prices.

At this pace, if the economic recovery continues, we’ll see oil prices well above $100 a barrel in 2010.  And you know what that means… we’ll be paying $3.50 to $4 a gallon for gas in no time!

Why are prices rising so quickly?

Clearly the oil market is ignoring the current fundamentals in the economy.  Demand for crude products is low, supplies of crude are growing, and unemployment remains high.  Yet, prices keep moving higher.

Let me tell you why…

First, the oil markets may be discounting the early stages of peak oil.  Even though we have millions of barrels of “resource slack” in OPEC and many billions of barrels of oil left in the ground, crude could just keep pushing higher due to growing global demand and peaking of global production, real or imagined

Geopolitical risk is high right now.  Tensions with Iran are building.  Iran refuses to give up on its nuclear ambitions.  Any military action in Iran will cause crude prices to explode in the short term.  Some investors are getting in front of this news.

Lastly, oil could be climbing on inflation fears.  The U.S. has printed trillions of dollars to avert financial calamity.  At some point, the affects of all the printing will hit the economy.  The U.S. Dollar may plummet and anything priced in dollars (like oil) will skyrocket.

But the bottom line is this…

None of these “fears” are playing out as of yet.  Peak oil theory can’t be confirmed.  There is no war with Iran.  Inflation (according to government figures) hasn’t even kicked in yet.

That leaves one last reason oil prices are still rising… blatant speculation.


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Category: Commodities

About the Author ()

Justin Bennett is the editor of Commodity ETF Alert, an investment advisory focused on profiting from the ebb and flow of important commodities via ETFs. The commodity veteran and options specialist is also a regular contributor to the Dynamic Wealth Report. Every week, Justin shares his thoughts with our readers on a variety of commodity-related topics. Justin is also a frequent contributor to Commodity Trading Research’s free daily e-letter. And he’s the editor of another highly successful and popular investment advisory, the Options Profit Pipeline.

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