Crude Oil Market Analysis (1/10/07)

Today the market action followed the forecast of the Crude Oil Market Analysis (1/09/07) (the “Jan. 9 COMA”).

The Jan. 9 COMA stated that “overall in tomorrow’s DOE report, unless the crude import falls to 9.5 million barrels per day or lower, the continued build in gasoline and distillate stocks will more than offset the draw in crude oil stocks and pressure the crude oil market towards $55.00. Once the market breaks $55.00 to touch $54.70, it will be a free fall towards $50.00-$50.40.”

The Jan. 9 COMA called for the effect of a significant build in product stock to offset the effect of a large draw in crude stock. Today the market heeded the gasoline build of 3.8 million barrels and distillate build of 5.4 million barrels while shrugging off crude draw of 5.0 million barrels.

The Jan. 9 COMA also called a crude import at 9.5 million barrels or below as the saving grace for the market’s continued downward trend. After the initial reaction to the DOE report, the market did bounce off from $53.89, one cent above the Jan. 9 low and an 18-month low of $53.88, as the market was mindful of the crude draw of 5.0 million barrels. But as soon as it became clear that the market could not rally above $54.85, the 2006 low, the market continued its downward trend and settled at $54.02.

Currently the market trades at $53.22 after reaching a low of $52.94. This is not surprising as the Jan. 9 COMA called for “a free fall” if the market would drop to $54.70.

Fundamentally, without a prolonged cold weather arriving by Feb. the market is slightly off balance at $53.22 with a downside risk towards $50.00.

So far no news can be substantively interpreted as bullish. On Jan. 9 Qatar’s oil minister’s talk of an early implementation of the 500,000 barrels per day cut failed to sustain a market rally from an 18-month low. The dispute between Belarus and Russia that first gave the market a boost on Jan. 8 has since been resolved between the two countries’ presidents.

Today Saudi Arabia announced cut in Feb. oil allocations to its Asian customers in China, Japan, and South Korea by 12%-14%, larger than the contractual limit of 10%. However, just as Saudi Arabia could not help bring down the oil price last July because the world did not need its sour crude, now Saudi Arabia cannot boost the oil price because its cut to its Asian customers is also mostly sour crude. Moreover, Saudi Arabia has announced no change in allocation to its U.S. customers.

It appears that Saudi Arabia is the only OPEC member who truly implements its share of OPEC’s announced cut. As the market drops below $55.00, instead of cutting productions now, most other members of the OPEC will likely increase productions—or at least keep productions steady. Based on game theory, if one member thinks that all the other members will be serious about cutting oil productions only if the price falls below $50.00, and every member except Saudi Arabia has the same strategic thinking, as the market falls below $55.00, it is the “catch-the-last-train” mentality because every member except Saudi Arabia will try to sell as much oil as possible while the price is still above $50.00 before they all recognize that at $50.00 per barrel or below they all have to cut productions in real term or they all will sink. Therefore, as the market trades below $55.00, it is unlikely that OPEC members will truly cut productions until the market falls below $50.00.

The OPEC production cut is the only potential bullish factor in sight, and it is not credible until the market drops to $50.00 or below.

Technically speaking, there may be a rather strong support at $52.50, as the market at $52.50 would have retraced by 38% from its high of $78.40 in the most recent bull market starting from 1998’s low at $10.32 to 2006’s high at $78.40.

Strategy: Hold short at $54.75 with a stop at $55.65; take profit below $50.40.

Dr. Chen