The Crude Reality

by: Timothy Charles August 10, 2008 | about stocks: USO    

Timothy Charles

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So here we are, crude oil sitting under the major $120 level. I had a discussion the other day with a person who has been bearish on crude all the way up from $70. The argument was just about the fundamentals of the market and the falling level of demand. I argued that such sometimes comes into play but for the most part, these numbers tend to lose you money trading these market - not make you money. Anyhow, the person went away all angry that I did not agree with him. My reasoning was somewhat simple: The crude market has not convincingly crushed the $120 level. If it did, then I would be calling a top but since the buyers have showed up, and the technicals overall somewhat support a move higher, I just don't think the cascade is there yet.

However, it could come to the party soon. To measure crude oil, I look at the commodities and the US Oil Fund (USO). I am not a big fan of the USO as the constant rolling of crude can distort the price action of the fund (lagging or leading it depending on the shape of the crude future curve). However the USO is useful because it provides me with a view of the retail investor's thoughts via the volume figures. Combining this together with my futures chart and economic outlook, I can reasonably come to a view on crude. So where do I think things are going from here?

Well, let's break down the parts and summarize at the end. First, the USO is telling me a few things. Money flow levels were at extreme levels around $140 a few weeks back. Generally speaking when this occurs, crude either accelerates and then levels off or it declines, like it did in late 2007. Since the extreme level, we have correct through one support area and now trying to hold a second around 95 (USO price). A break here could really open up the flood gates and set up a test much lower around $80. A break to this point though would probably flip over the power model to bearish and then my targets would be in the $50's range. So from the ETF side, crude is at support but a bounce soon will lead to another fall towards $80.

As for the futures charts, the long term monthly argues we are heading back to $110 which is somewhat opposite of the weekly which is kind of showing support at $120. Key word here is kind of though which means that if the speculation is correct in the marketplace and index funds are unloading on the market, much like they did with stocks a few months ago, there will be no bounce at $120 and $110 will become more of a certainty. A break of $110 and things get very interesting with $100 and then $80 next.

The last variable is the economy. During the previous cycles of my growth model, which measure whether we are in a bear or bull market, the crude market has leveled off during the bear side of the trade. If that is the case, then my friend, who has been wrong since $70, might actually be correct. My model turned over in November of last year. Crude was around $85/90 per barrel at that time. If the past is a guide here, crude should trade to this level and then bounce probably another 10 lower before returning to the mean, if you will.

So in summary, the USO is bearish, the futures are bearish and the bull/bear model is bearish. The average target looks to be $110 but longer term, it appears we are headed for a test with the $80 level. Further economic weakness could be a real problem though I think the dollar would weaken in such a scenario (unless the Euro falls apart) and crude will find some artificial support.

Disclosure: none, though that can change at any time as I do trade the energy markets.

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This article has 12 comments:

  •  
    Aug 10 08:04 PM
    Agree present conditions argues for bear market in price of crude oil.
    Reply | Link to Comment
  •  
    Aug 10 08:25 PM
    On my documented free website Short Jester who has had 96% successful trades has shorted this more than 10 times and profited. He said that the fundamentals say that the price has downward pressure.This article says about the same.The president of Gulf Oil said the price of crude would be under 100 by the end of the year. Time as it always does will tell
    Reply | Link to Comment
  •  
    Aug 10 08:56 PM
    There is an untold social cost that has as yet to be accounted for. We've already seen a reduction in miles traveled, on roads, highways, airlines and the surge in public transportation. The cost model for fuels will have to do more than to use weather forecast and foreign upheaval. It won't be so much the elasticity of price, fear and demand anymore, than the new standards in which the demand is gauged to begin with.
    Reply | Link to Comment
  •  
    Aug 10 09:18 PM
    If it does fall as you predict that will further delay progress toward alternatives, mothball exploration, increase demand from parked SUVs and result in even higher prices in the future. Unless of course production can be increased by millions of barrels a day of light sweet crude.
    Reply | Link to Comment
  •  
    Aug 10 09:31 PM
    Oil price plunge due to demand destruction can not sustain. There are only two scenarios that can put oil price into a secular bear market: 1. major new supply of more oil production, 2. substitute cheaper energy

    We don't have the two scenarios happening, so forget about sustainable cheap oil prices.
    Reply | Link to Comment
  •  
    Aug 10 11:58 PM
    Only two comments:
    1. Parabolic chart is always a bubble. When oil went over $100, it was in a bubble, supply and demand didn't matter.
    2. There is a lot of new oil production. Oil is going to $70.
    Reply | Link to Comment
  •  
    Aug 11 04:05 AM
    new production of light sweet sweet crude? tell me where, plzthnx.
    Reply | Link to Comment
  •  
    Aug 11 06:05 AM
    going forward, at least near term, heavy sour crudes will see a revival in interest due to KSA stopping fuel oil exports, thus creating a supply gap that refineries elsewhere will have to fill. the cold season is coming up (given crude delivery schedules and production lead times it is already quite near) which is when demand for fuel oil is strong. expect fuel oil refinery margins to increase along the line.
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  •  
    Aug 11 06:50 AM
    just another useless 'technical analysis' humbugthat claims to have a clue about future oil prices. technicak analysis is not all total crap - it can serve you well at times. But certainly not this usual trendline, oversold, overbought, macd etc. etc. nonsense. This works a few times by chance and loses you money in the long run with 100% accuracy.
    But people never learn. Every day another sucker is born who claims to have a clue and a truly predictive system when in fact, he just assembled the right data in the right way to show some random correlation and some predictive power. 90% of the often disregarded 'simply buy and hold'-investors are better off in the long run than the gazillion short-term traders with their data-mined and curve-fitted 'systems' Go figure.
    Reply | Link to Comment
  •  
    Aug 11 11:23 AM
    I prefer to look at fundamentals to try to ascertain future demand.
    Charts for most investments appear to be 20/20 only in hindsight to me.

    There are two types of fundamentals in play when it comes to oil.
    There is traditional supply and demand, as well as a host of "political fundamentals," which represents government intervention in the marketplace.

    As for the traditional fundamentals of oil, the supply seems stuck at about 84-86 million barrels per day. While there is some demand destruction occurring (temporarily?) in the U.S., emerging economies elsewhere will continue to call for more oil.

    Then there's the "political" side of the equation, which impacts oil prices unlike virtually any other commodity. This ranges from OPEC ("the 800-pound gorilla in the room") to U.S. government regulation, which artificially impacts supplies in the nation that utilizes 1/5 of the world's oil.

    As Wall Street watches the Congress live on C-Span this fall, the pro-oil forces have the upper hand. Fully 3/4 of Americans want to open up our nation to increased exploration, and the politicians see that. Even if the anti-oilers stand fast, the Congressional moratorium prohibiting drilling in the OCS will end October 1.

    It is my contention that the prospects for more U.S. supply and less federal regulation are what's causing the price of oil to fall in the U.S. If this is so, barring any major moves by OPEC, Mr. McCain's would be bullish for $60-80 oil, while President Obama would mean oil at $200-plus over time.



    Reply | Link to Comment
  •  
    Aug 11 01:52 PM
    Short term (6 months) oil down, to $110/barrel; intermediate term (6 months - 5 years) oil up, to ~$150/barrel; long term (5 - 10 years) oil up (~$150/barrel; ultra long term (10 - 20 years) oil at $110/barrel (all measured in today's dollars).

    Save this, and see.
    Reply | Link to Comment
  •  
    Aug 12 07:45 PM
    If oil hits 80 dollars a barrell , there won't be any oil .
    Reply | Link to Comment
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