Oil Prices
US OIL FUND ETF
NYSE: USO
May 22
no chart
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Last price33.46Prev Close34.11
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Change-0.65% Change-1.9%
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Open33.78Volume10,596,600
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Day Low33.40Day High34.10
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Bid33.63Ask33.64
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52 Wk Low29.4652 Wk High36.84
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Market Cap19,675ExchangeNYSE
Today
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Why Oil Prices Can't (and Won't) Collapse
The markets opened again yesterday after the tragic storm across the East Coast.
In a world ravaged by storms, geopolitical tensions, rising demand, supply concerns, and increasing costs, it's important to know what's really driving oil prices moving forward.
The most important thing you can know is that increased market volatility is not going away. The challenge, of course, is to harness these volatile forces in order to come out ahead in the future.
That's the subject today. First I need to set the picture of where we are today.
There has been persistent talk from the usual sources that the price of oil will collapse, along with a range of field support and midstream service providers.
There is just one problem with this argument.
It's just not going to happen.
Don't get me wrong. I am not suggesting that the accelerating volatility in oil prices will point only in one direction, or that the trajectory is straight up. This is not going to be the first half of 2008 revisited.
Rather, we will continue to experience intense movements over shorter intervals. This is what statisticians call kurtosis - greater amounts of volatility occurring in shorter cycles.
Despite the overall upward trend demanded by indicators, these more compact movements will occasionally go in either direction.
That means we can experience downward spikes restraining oil prices over shorter durations. Nonetheless, the overall medium-term dynamic continues to move up. This is producing what I call a "ratcheting" effect: The market prices will undergo downward pressures within a basic upward tendency.
So where are oil prices going?
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Oil Prices: As the WTI-Brent Spread Widens, Refineries Are Set to Advance
Brent and WTI crude oil prices have been on a downward trajectory. Recently Brent had declined for seven consecutive trading sessions while WTI had been down for five.
Given the importance these benchmarks have in pricing crude worldwide, it is useful to review what they are before talking about their widening spreads.
Brent and WTI (West Texas Intermediate) are the two principal crude oil price benchmarks of global trade. Brent is set in London, WTI on the NYMEX in New York.
As I have observed in Money Morning on a number of occasions, neither benchmark actually reflects the quality of the oil traded worldwide.
On average, 85% of the oil in the international market on any given day is more sour (having a higher sulfur content) than either of these benchmarks. That means the actual trades are done at a discount to the price of one or the other of these standards.
Both are denominated in dollars, the currency in which virtually all oil consignments internationally are priced. That certainly is one primary reason for their continued use.
In addition, the daily liquidity of futures contracts traded in the world's two largest investment locations is yet a reason for their use.
Finally, with more than 200 benchmark rates for crude existing throughout the world, most having insufficient volume to constitute a basis for oil prices, there needs to be yardsticks to determine pricing differentials and swaps.
Those common yardsticks should be the most liquid and highest volume trading contracts available.
Brent and WTI fit the bill in all of these aspects, despite the fact they don't reflect the lower quality of most oil traded.
Oil Prices: Global Markets Favor Brent Crude
Still, the most interesting development since mid-August 2010 has been the following: despite representing lower quality oil, Brent has been trading at a premium to WTI.
Of the two, Brent has more sulfur content. That should result in a lower price rather than higher comparative price.
Actual trading conditions prompt a spread in favor of Brent for several reasons.
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Why Oil Prices Are Entering a "New Normal"
One of the things I have learned from almost four decades of doing this is that oil and gas specialists know a great deal about what they do for a living.
However, few of these specialists really understand enough about what the person to the right or left of them does. This tends to breed tunnel vision.
And these days it has become a serious problem.
That's because what is now hitting the oil and gas markets requires a more expansive and integrative understanding of what is actually taking place.
The truth is energy markets are evolving.
We are entering a period in energy and oil prices that I have begun calling the "New Normal."
You see, a volatile, dynamically changing combination of factors now undermines the traditional way of viewing oil and gas markets.
And it is about to get a whole lot more unnerving for the average analyst who still insists on pushing square pegs into round holes.
Unfortunately, for the old school aficionado, we are rapidly moving into new territory. Here, market machinations are occurring that defy the "traditional" explanations.
Oil Prices and the Talking Heads
You know what I mean by "traditional."
The talking heads on television try to explain the latest spurt or dive in oil prices by relying on the same trite and tired lineage of explanations.
In just the last month, we've seen movements in energy prices justified solely on the following factors:- A supply glut in Cushing, Okla.;
- Fluctuations in the euro-dollar exchange rate;
- The European credit crunch;
- The latest unemployment figures;
- Inflation;
- Manufacturing, housing, or production figures.
There are several factors contributing to this New Normal, but I will be restricting my comments this morning to just three.
They are:- The balance between conventional and unconventional production;
- Increased market volatility; and
- Global geopolitical matters.
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There is Nothing the Shorts Can Do About Higher Oil Prices
After another pricing pull back of almost 10% earlier this week, crude oil prices rebounded on the back of an unlikely source.
A Spanish deputy prime minister presented a budget. The proposal was hardly earth shattering.
It detailed planned expenditure cuts but provided no details on the other shoe that has to fall - tax increases. Given that a main element in the Eurozone crisis continues to be on the fiscal side, tax increases will have to follow.
The difference cannot be made up only from program cuts. The budget announcement, therefore, appears simply to forestall the inevitable.
Nonetheless, a dry news conference in Madrid was the latest excuse for bulls to take over and drive the oil price (and the markets) higher.
This is merely the latest example of an immediate overreaction to developments.
Yes, it is important that Spain is positioning itself to benefit from the new paper buyout plans being orchestrated by the European Central Bank (ECB).
Unlike the basket case of Greece, the Spanish have made an effort to clean up their act prior to a bailout request.
Next up are the stress test results of Spanish banks. An independent audit show Spanish banks need $76.3 billion.
And while there is some question over whether the test is a valid indicator of overall banking sector weakness, there is no doubt what the government's objective is.
This will not be an across-the-board rescue of the banking sector because Madrid does not want a full-blown rescue from the EIB.
That would put the entire Spanish banking industry under pan-European oversight. Now it may ultimately come to that. But before officials capitulate, they will orchestrate a smaller number of comparatively healthier financial institutions (at least on paper).
This hardly ends the crisis.
But it does indicate that a strategy is taking shape. And that is all the bulls needed to charge forward.
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You Can Drill All You Want, Oil Prices Are Still Headed Higher
Today I want to focus again on oil prices. It seems that some TV pundits have never heard (with apologies to Alexander Pope) that a little knowledge is a dangerous thing.
Some people on Wall Street believe that by scaring the individual investor they stand to make a greater profit for themselves.
Over the summer, there was a report issued by Credit Suisse that said that oil could hit $50 a barrel. We've also seen predictions on CNBC saying $40 a barrel. Others think that oil prices could fall even go further.
What I am telling you now is that these views do not reflect the actual market or the new reality we find ourselves in today.
A lot of this sentiment stems from the idea that we have now increased our supplies here in the United States. Some political candidates even said that they guaranteed "$2.50" per gallon gasoline if they were elected.
"Drill, baby, drill" has become something of a national catchphrase.
The problem is that prices are not just reflective of new supplies, either too much or too little. By focusing only on how much is there, these analysts provide a fundamentally distorted view of the oil market.
Yes, the rise of new sources has altered the picture. But so has the rise in demand globally and at a rate much faster than anticipated.
In fact, the impact of unconventional oil (like our huge sources of shale oil) is now projected to be less than expected, even with additional volume coming on line.
And one report issued last week reflects that fundamental view and explains why oil prices are set to rise, not fall in this age of expanded unconventional oil and gas.
The Fundamentals Are What Matter to Oil Prices
I want to introduce you to a company called Bernstein Research.
They are regarded as the top energy research company in the world by their institutional investors. They're in 40 countries. They win awards every year for having the best analysts in the sectors they cover.
And they are very successful in their forward focus because they emphasize the fundamentals.
Last week, Bernstein Research released a detailed report reflecting the position I have been holding for some time-oil prices are headed higher.
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Higher Gas Prices a Sure Bet Due to Hurricane Isaac, Fire
Production halts due to Hurricane Isaac and a deadly explosion at a Venezuelan refinery have pushed U.S. gas prices to a near four-month high.
As the hurricane hit land yesterday (Tuesday), oil and gas production in the Gulf of Mexico had virtually shut down. Oil companies now must wait out the storm before they can assess any damages.
Energy firms in the region have suspended 93% of the typical U.S. oil production and 67% of natural gas in the gulf, according to a report released Tuesday by the Bureau of Safety and Environmental Enforcement. Companies have evacuated 503 platforms and 49 rigs in the region.
In addition, gasoline refiners have shut down approximately 6.7% of total U.S. refining capacity, a move that will lead to reductions in gasoline inventories and short-term price increases. Exxon Mobil Corp. (NYSE: XOM),Phillips 66 (NYSE: PSX)and Valero Energy Corp. (NYSE: VLO)all reported yesterday that they have temporarily shuttered Gulf Coast refining operations.
But Hurricane Isaac's disruptive presence isn't the only strain on the U.S. refining network. There's another major catalyst triggering higher gas prices.
Over the weekend, tragedy struck the second-largest refinery in Venezuela.
An explosion and fire on Saturday at the Amuay refinery in Venezuela killed 48 people, wounded hundreds, and destroyed hundreds of nearby homes. It is the deadliest refining accident in more than a decade.
The government-run Petroleos de Venezuela (PDVSA) owns the plant, which can process 645,000 barrels of oil a day but has been forced to suspend operations.
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Ignore the Doom-and-Gloom Crowd When They Talk About $40 Oil
I just returned from a week down South with a few of my energy clients. It's good to get my hands dirty and remind myself firsthand what is going on at the project level of some of the country's top energy companies.
But when I returned home this weekend, I made the mistake of flicking on the television and opening the newspaper.
I can't believe that the pundits are now predicting that oil will fall to $40 a barrel. They also are projecting that the entire natural gas sector is going to collapse.
Here we go again.
Yes, we are wrestling with an energy sector that remains gun shy on elements from market volatility to geopolitical tensions.
And sure, $40 a barrel is possible, but only in an improbable situation where global demand for oil completely collapses, along with the world economy.
But we are in a new reality. And such doom and gloom predictions are highly oversimplified and potentially dangerous to you as an investor.
Here's why.
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Oil Prices Promise to Head Higher As Mexican Production Dwindles
In addition to Iranian threats and growing demand, dwindling production of crude in Mexico promises to push oil prices higher as well.
Mexico is the third biggest exporter of oil to the United States. That's bad news for the U.S. economy which always gets hit when oil prices rise.
From 2004 to 2008, the U.S. Department of Energy reports such jolts, along with OPEC price manipulation, cost roughly $1.9 trillion. Plus, a recession followed each major blow.
According to the U.S. Energy Information Administration (EIA), Mexican oil production reached a peak of 3.2 million barrels a day in 2008. And by 2011, it wasn't even producing 3 million barrels a day.
Since then oil production has slipped to 2.5 million barrels a day.
Worse still, Mexico could actually become a net importer of oil within a decade if it cannot find fresh discoveries to make up for the 25% production drop since 2004 and fails to change its current policies.
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Oil Prices are Higher, But It Won't Be Much Help for Alternative Energy
Normally, when gas and oil prices accelerate on both sides of the Atlantic, alternative energy sources come into focus and become a big part of that "energy independence" discussion.
Well, not this time.
During the run up to mid-$4 gas and $147 a barrel oil in 2008, many assumed these costs would continue to advance. That made alternative sources - especially renewables such as solar, wind, biofuels, and geothermal - more attractive to investors, politicians, and energy enthusiasts.
Alternative sources are more expensive than conventional oil, gas, or coal. They are, however, more environmentally friendly. Paying those higher costs was regarded as a tradeoff for cleaner energy sources and a reduction in emissions.
Today, that view has changed.
U.S. Oil and Gas Squeezes Alternative Energy Prospects
It's part of the reason why I've recently avoided alternative energy companies like First Solar (Nasdaq: FSLR), Canadian Solar (Nasdaq: CSIQ) or SunPower Corporation (Nasdaq: SPWR) in my Energy Advantage portfolio.
The economic downturn has made reliance on more expensive energy sources a difficult proposition to accept. Renewables are hardly a convincing argument anymore, especially during a sluggish economic recovery.
Yes, increasing oil and gas prices should reduce the spread between conventional and renewable, thereby providing stronger arguments for change. And proponents argue that alternatives provide an enhanced advantage given that they can also be domestically produced.
Just don't bet on these arguments holding up this time. Here's why.
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Why a Strategic Petroleum Reserve Release Won't Help Oil Prices or President Obama
With oil prices showing no signs of retreat during the final months of the U.S. presidential campaign, beltway insiders are turning to one misguided solution to combat rising oil prices.
Releasing oil from the Strategic Petroleum Reserve (SPR).
Trial balloons floated all over Washington during the past few days. The only reason politicians didn't move on this sooner (say a few months ago) was the price level.
Until the last month or so, both oil and gasoline prices were heading in the other direction. Near-month futures contracts for West Texas Intermediate (WTI), the crude oil benchmark traded on the NYMEX, were below $78 a barrel in intraday trade toward the end of June, while the same futures for RBOB (the NYMEX traded gasoline contract) were at $2.55 a gallon.
At the time, all the sage pundits predicted that oil would fall below $60 a barrel; some even suggested that prices could approach $40. On the gasoline side, these same wise guys were proclaiming we may see prices at the pump breach $3.
Everything has changed quickly.
Yesterday morning the markets opened with WTI 23% higher than late June and RBOB up by more than 20%. Oil stands at more than $96 a barrel in New York, while Brent has exceeded $116 a barrel in London. And retail gas prices are once again approaching $4 a gallon.
Recently, I discussed why oil prices are moving up. But for some politicians, including the fellow running for reelection at 1600 Pennsylvania Avenue, those prices are becoming a job liability.
So it's back to hitting the SPR.
But there are four reasons why tapping the SPR won't make oil prices any cheaper in the end.
Maybe you should let your Congressman know about them...
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