Just posted this blog... Please post thoughts. http://scriabinop23.blogspot.com/2008/05/crude-oil-on-direction-and-equity.html My eyes have been on crude, and I'm genuinely confounded on where it goes. I've been burned too many times trying to short crude lately, thinking for a while that this was a speculation driven ascent - but the last two EIA reports show support for this latest move. This is an example of price action showing fundamentals before the reports do. The latest EIA petroleum status report shows a draw in crude stocks that simply dwarfs the impact of a week over week reduction in product imports (Some 8M barrel draw of crude against 4M barrels less imports). Additionally, a net draw in major product (1M or so between gasoline and distillates) stocks points to refiners producing and actually selling more product than being produced. I would discount a draw in stocks only if there was a matching build in products to offset this - that would say it is merely a function of refinery behavior (simply overproducing). But instead this looks like supply falling faster than demand. I know I'm late to the game (well not entirely, if you consider my first blog from 2006 asserting Peak Oil), but I think this may be the long awaited "Peak Oil Supply Crunch." Reading the news of the recent CFTC investigation and Michael Masters' testimony acknowledges the public thought the same as what I suspected all along. A natural contrarian, it makes me suspicious - this seems like a smokescreen to placate Congress. Was the optimist in me suspecting this ascent was a conspiracy, not wanting to acknowledge that this may indeed be the supply-side driven crunch where genuine product demand simply outpaces supply? It was easy to deny after all, since EIA reports this past few months were not overly bullish, minus the events in the distillates market. All of this intersection of politics and financial stockpiling conspiracy suggests that perhaps the truth is somewhere else. A recent read of UCSD Professor James Hamilton's 'Understanding Crude Oil Prices' lends more support to the supply deficiency argument. Simplified, he asserts that we will know quickly if this price ascent is due to market manipulation by an eventual flooding of stockpiled inventories by financial players cascading out as quickly as they entered the market, in efforts to avoid losses. You can never avoid equilibrium in the long run. The laws of economics ultimately decide where price goes. The jury is still out where demand destruction occurs enough to offset any potential supply crunch going forward. The end to near term pre-Olympics Chinese diesel stockpiling as well as emerging market price driven demand destruction are two forces to watch. One must not forget that a developing world income (China per capita income in urban areas of $1500/year in 2006) coping with already high food prices (25-35% of their expenditures) simply does not have much spare cash for unsubsidized oil products that cost $3.50/gallon. The same story holds true for business models that these developing urban populations have capitalized in the past several years. This all leads to a fall in crude - A fall that additionally supports my point for lower yields as we turn into (global) recession, and sentiments once again shift downward. In the end it boils down to the health of the economy, and that is reflected in equity prices. Not until crude gets back to $25-50 do lower fuel prices actually act as a growth stimulus, despite the illusory-inspiring short term negative correlation between equities and crude. At this point, inferring the implications of equity negative correlation to crude too literally can be dangerous. As the markets pass through crude cost, the price at which crude merely has neutral effect on profit margins will be discovered. At this point, the crude markets will need to make more drastic moves to maintain current correlation. Unless wages catch up, as price pivots above some arbitrary number (lets say $75), high crude will act as a negative pressure. Thus a move from $135 to $125 simply means less bleeding. But it still is bleeding, and eventually the markets will see this and start ignoring crude price descents unless justifiably more substantial and long lasting.
Personally I'd love to get a good explanation as to why gas prices immediately skyrocket on news that sends futures incrementally higher, but have no immediate actual effect on the current supply of refined gasoline. And why the reverse holds - the high gas prices stay high for a while after we get news that sends futures shuffling back down. The refiners have maintained all along that there is no gouging taking place. Something does NOT add up...