Why is Oil Dropping (and what might its impact be)?
Oil has dropped under $60 this morning, to reach 6 month lows. Prices have "dropped more than 23% since hitting a record $78.40 in mid-July." At the same time, stocks have closed in on their May highs.
Why has oil dropped so precipitously over the past 2 months? AP notes that:
"The high prices in July and August were largely fueled by concern over the possibility that Iran could disrupt oil supply if sanctions were imposed or if the monthlong conflict between Lebanon and Israel escalated. Fears of hurricane damage to U.S. Gulf Coast refineries also drove the market higher this summer but the storms so far have blown past the coast."
Here is a short list of the most common current explanations circulating in MSM:
1. More Supply coming online;
2. Reduction of global terror threat;
3. Cooling of hostilities between Israel and Lebanon
4. Seasonally weak demand, as Hurricaine season ends;
5. Iran cooling inflammatory rhetoric
I find these some of the mainstream explanations unsatisfying. At the risk of creating a strawman (only to knock it down), let me put forth my top 5 list:
1. Fast money rotating out of commodities and into tech;
2. Cooling economy consuming less energy;
3. No major supply disruption from weather or Middle East;
4. Psychology peaked earlier in year; (see Business Week Cover Story)
5. Stretched consumer shifts behavior;
6. And lastly, theWeakStrong US Dollar (Crude is priced in greenbacks)
The biggest mis-statement on the mainstream list/energy discussion is the perplexing meme that somehow terror concerns have been alleviated. I find that rather astonishing, given that the leaders of two of the larger Oil suppliers were in NY at the UN last week talking trash about the Unied States of America.
The eventual confrontation with Iran -- last I checked, they had not given
up their nuclear ambitions -- is still looming on the horizon.
On top of that bit of psycho-drama, we learned this weekend that US Spy Agencies Say Iraq War Worsens Terrorism Threat.
So the new idea that somehow the terror threat or the Middle East turmoil has improved fails to resonate with me.
All these explanations remian squishy, however. When in doubt, we go to the charts:
Crude Oil, 6 Month Chart
click for larger chart
Crude Oil, 3 Year Chart
click for larger chart
<
Major Support for Crude is at $58, minor support is at $55 and $49.
Oil is in the midst of a major correction, and by the traditional measure of 20%, can be defined as in a Bear market. The mainstream explanations are greatly over-simplified.
Why is this important? Understanding why energy prices have dropped can help you avoid positioning your portfolio on unrealistic assumptiuons . . .
><
Source:
Oil Falls Below $60 a Barrel As Supply Concerns Ease
Associated Press, September 25, 2006 4:36 a.m.
http://online.wsj.com/article/SB115916984508472928.html
Monday, September 25, 2006 | 07:39 AM | Permalink
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Tracked on Sep 25, 2006 4:10:21 PM
Comments
Boone Pickens was quoted last week going with #2, a cooling economy is slowing demand.
Posted by: mh497 | Sep 25, 2006 8:15:14 AM
Hi Barry. I would be curious how you would analyze the charts of gold and the gold stocks as well. Only if that interests you, of course. ciao.
Posted by: lurker | Sep 25, 2006 8:16:43 AM
Oil...is correcting itself relative to GC. ☺
Posted by: MrMarket | Sep 25, 2006 8:25:12 AM
Barry,
I couldn't agree more with you regarding the reasoning behind the fall in oil prices. A look at the CRB shows oil is not alone. Copper, rubber, precious metals have all fallen. This reflects the slowing of money velocity. The global economy is slowing. EIA publishes imports, production and stocks of oil. If you add the first two, subtract changes in the last you get U.S. consumption. Consumption has fallen off greatly, showing an economy falling into recession. That's the fundamental story. Add speculative position squaring and we get the free fall. The equity market is reading this all wrong. The falling commodities prices are a symptom of the problem, not the stimulus of a rebound.
It will take continued bad econ prints for the equity market to get the joke.
Cheers,
jda
Posted by: J Arp | Sep 25, 2006 8:25:33 AM
I would add that I think that the fast money is getting stopped out (and smoked) and scrambling to sell. I don't think Amaranth was the only fund with a bet gone bad, most especially considering that it is a 23% correction in a very short time.
Posted by: Mike | Sep 25, 2006 8:27:35 AM
I'm going with fast money bailing out on their speculations. The falling demand aspect would show up in energy department or other industry statistics, wouldn't it?
Posted by: Royce | Sep 25, 2006 8:35:11 AM
Your strawman #1 gets my vote. War speculation that drove oil into "contango" required hedging forward to $70-78/bbl to keep from taking a loss. July hit that target.
Contango is not over, but on the wain as hype (futures) catches up with reality (spot).
Posted by: Ddrich | Sep 25, 2006 8:49:11 AM
I think russwinter hit the nail on the head:
Goldman Sachs Games Gasoline Futures
Goldman Sachs elected in July to arbitrarily game their widely followed commodity index. Illustrating how this can be done, and with no questions asked, they suddenly changed the unleaded gasoline component of the index from 8.45% to 2.30%, right at a point in time when speculative funds were heavily long. In addition GS blew up the arbs with this jewel,
"On July 12, 2006 Goldman, Sachs & Co. announced that, for the roll occurring in September 2006 (the September Roll) in relation to the Goldman Sachs Commodity Index (GSCI) futures contract expiring in October 2006, it would roll the existing portion of the GSCI that is attributable to the Reformulated Gasoline Blendstock for Oxygen Blending (RB) futures contract on the New York Mercantile Exchange but would not roll any portion of the GSCI that is attributable to the New York Harbor Unleaded Gasoline contract (HU) contract into the RB contract."
What a coincidence, duh. Per usual I smell another rat. The result was predictable enough given that index-linked commodity funds would be forced to liquidate 73% of their unleaded gasoline futures to hit the absurd tiny new 2.30% threshold. And not surprisingly, this energy liquidation has been so intense that specs are now modestly short both unleaded and heating oil, and are completely gone from long positions in crude oil. This price rout has absolutely nothing to do with demand fall offs. In actuality, the post Labor Day seasonal gasoline consumption drop has been slow in developing, with the last four week average year over year, up a substantial 5.4%.
In addition this plunge has been a key driver in the drop in all kinds of Old Maid Card and Ponzi finance related interest rates, under the "inflation is being licked" banner. There has even been a nice pickup in refi and housing purchase activity, suggesting to me that September housing data will come in better, sparking more soft landing talk there. As they jettison energy positions, speculators have instead continued to intensely pile into 10 year Treasury notes with abandon, and are now net long a stunning 401,314 contracts. Yields have fallen so low (4.59% on the ten year and a whopping 66 bp below the Fed fund rate), that at last, it may have gotten the attention of FCBs, who liquidated a historically high $16.1 billion in Treasuries in the latest reporting week. My hunch is that the FCBs trump offside Riskloves and speculators any time, and any place, making this weekend's set up dicey at best for the bulls.
Posted by: Steve | Sep 25, 2006 8:51:52 AM
Lets see if crude closes here today < $60 / bbl. If so, we could see some capitulation in the energy markets this week. Although the trrend in energy prices should still be up long term based on economic growth, I yeild to the efforts of the US Fed to stop inflation and the efforth being spoken about by China. If China can effect a moderation in their growth is the big question. If housing in the US gets slammed year end, could be a phsycological thorn in the US's economic side. However, some of these premiums coming out of oil priceing has been talked about since the begining of the year. volitility should persist as seasonal and secular trends continue in that market....good time to be a little short! Don't expect OPEC to help out.
Posted by: snook | Sep 25, 2006 8:53:06 AM
The easy flip from $80 & Mid East worries in July to sub $60 and excess supply tells us a lot about the speculative long. You can bet that not too many smart people were shorting above $70. Shorts getting active now.
Posted by: KD | Sep 25, 2006 9:01:26 AM
I'm voting for #3. Oil traders were quaking every time a tropical wave came into the gulf this year. When nothing happened, goodbye storm premium. (Note that the drop has coincided quite nicely with this year's hurricane season).
Posted by: M1EK | Sep 25, 2006 9:04:43 AM
Ummm, mid-terms?
Posted by: Aaron | Sep 25, 2006 9:05:50 AM
Wall Street is so funny. When oil was rocketing any particular statement or nit was a catalyst for higher prices. Or so we were told. Now that prices start dropping, Chavez comes out and calls Bush the devil and oil goes down. How many times did world events happen when oil was less than $20 and nary a time did it drive prices to $80. I can't tell how much is misinformation and how much is simply people who don't know what they are talking about moving their lips.
Posted by: BDG123 | Sep 25, 2006 9:39:40 AM
Oil traders were quaking every time a tropical wave came into the gulf this year.
salivating's more like it. but i agree the hurricane premium can be dismissed easily. fast money may be rotating out of oil, but a big reason it rushed in was the assumption of another harsh hurricane season. not that the season hasn't been active (12 named storms), just that few of the storms have hit the areas traders hoped...er, feared.
also of note regarding the lack of damage on these shores is there won't be a construction pop -- though granted a ton of rebuilding from last year is still happening. it's often said though these storms are economically net positive given all the insurance payouts.
Posted by: j d ess | Sep 25, 2006 9:51:09 AM
er, that should read "the hurrican premium *cannot* be dismissed easily..."
Posted by: j d ess | Sep 25, 2006 9:52:34 AM
Reasons 1 - 4 are sound. But a falling dollar? Shouldn't that make oil prices rise in dollar terms, as oil priced in dollars becomes more attractively priced in Euros and Yen?
Posted by: ddresser | Sep 25, 2006 10:08:40 AM
Hey Lurker, let me analyze the Gold Stocks for u;
They've been a HOUSE OF PAIN all Qtr long. Now fund managers have two days to decide if they keep them on their Qtr End statements. Get the picture.
We got downgrades on the Steels and Aluminums today and I wouldn't be surprised to see downgrades on the Golds tomorrow or Wed.
Shenanigans - Come on along and play Shenanigans
I'm betting that the lid comes off later this week.
Posted by: tjofpa | Sep 25, 2006 10:22:53 AM
I think he mistyped. The dollar has been relatively strong recently. And oil is inversely correlated to the buck.
Posted by: BDG123 | Sep 25, 2006 10:37:22 AM
The dollar index is down significantly from its Q3 peaks; It is also down significantly for the year.
It is up however, from its recent lows
I usually prefer weekly to daily charts (less noise) but even the daily shows the index US dollar index moving towards the bottom of its range
Posted by: Barry Ritholtz | Sep 25, 2006 10:45:35 AM
commodities trade inversely to the $
Posted by: dl | Sep 25, 2006 10:47:50 AM
... and will we see another "lagged effect" in the $ index as it reacts to today's increase in expectations for a rate cut by year-end => tomorrow.
Posted by: tjofpa | Sep 25, 2006 11:02:02 AM
There was a Congressional report released a couple of months ago that indicated that a large part of the high price of oil was due to speculation, specifically the over the counter (not sure if this the correct term), largely unregulated trade.
If there is less speculation, presumably the price drops.
Posted by: NotAPro | Sep 25, 2006 11:39:43 AM
thanks tjopa. your perspective is interesting and sounds sound. good as you know what.
House of Pain---LOL.
Posted by: lurker | Sep 25, 2006 11:52:27 AM
S.F. Chronicle article. :
http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2006/09/24/MNGNSLBRUG1.DTL&feed=rss.news
"Chavez drives a hard bargain, but Big Oil's options are limited"
A piece of the picture on the general topic of global oil dynamics...might be a good one for your linkfest next weekend Barry.
Posted by: babycondor | Sep 25, 2006 12:01:48 PM
"Understanding why energy prices have dropped can help you avoid positioning your portfolio on unrealistic assumptiuons . . ."
Could someone help me out here and clarify what are REALISTIC assumptions vis-a-vis energy, and how those assumptions would be reflected in my portfolio's positions?
Posted by: babycondor | Sep 25, 2006 12:05:53 PM
