Crude Oil Market Analysis (1/19/07)

Today’s market followed yesterday’s forecast that the market would begin to be range-bound despite having set a new low for each of the previous eight consecutive sessions, and the market had a sharp rebound.

The market moved in one direction from the overnight low of $51.48 to close at $53.40 for a $1.59 gain.

Currently the market is still very dynamic, as speculators play an “I-dare-you” game.

Fundamentally the market remains weak. The IEA reported on Jan. 18 that the oil demand in the 30-member OECD countries in 2006 fell for the first time in 20 years by a nominally insignificant 0.6%; however, the demand indeed decreased in 2006 in response to the record-high oil price. Oil demand in developed countries, however inelastic, finally responded to high prices when the price reached above $70 as oil consumers began to seek alternative sources of energy such as ethanol.

In addition, the IMF forecasts that Nigeria will spend $1.25 billion improving the oil-rich Niger River Delta in the run-up to April’s presidential election. Such spending will ease the tension in the region and bring Nigeria’s crude oil production from 2.35 million barrels per day in 2006 to 2.53 million barrels per day in 2007.

However, the demand decrease in the wake of $70 oil price may be transient, as oil consumers’ behavior will return to the old habit at a time when the oil price has gone back to $50. Moreover, with oil at $50 and corn price near record high the production of ethanol becomes unprofitable and provides a disincentive to provide an alternative source of energy. In other words, the rationales for shorting the market at $70 are no longer viable once the market falls to $50.

Moreover, the economy stays healthy, as the core CPI increased by a modest 0.2% in December, and the preliminary reading of the Univ. of Michigan Consumer Sentiment Index for Jan. rises from December’s to 81.3 to 98, the highest since the 103.2 reading in Jan. 2004.

All these factors contribute to a battleground for the bulls and bears at $46.20-$54.86. The CFTC’s COT report shows that for the week ending on Jan. 9, the non-commercial interests had gone from a net long of 2,194 contracts to a net short of 22,358 contracts, a whopping change of 24,552 contracts amidst an increase of 53,651 new open contracts. But in the following week ending on Jan. 16 the net short interests fell by 20,326 contracts to merely 2,032 contracts amidst another huge increase in open interest by 37,088 contracts. In a matter of two weeks, the open interests have increased from 1,226,641 contracts to 1,317,380 contracts for a 7% increase. In other words, as the longs are convinced that the market is going to turn at this moment, the shorts are sitting tight waiting for the next leg of downward movement. The sharp increase in open interests in the past two weeks explains the volatile market movement both intraday and during the two-week period. Likewise, when either the longs or the shorts decide to bail out, the market movement will be equally volatile.

Crude Oil Market Analysis’ observation of the increasing appetite by speculators in crude oil is contrary to the conventional wisdom that big speculators have shifted their money from energy and metal to agricultural products. Nevertheless, Crude Oil Market Analysis is concerned only with the fact, not with market perception, and the fact is that both the bulls and the bears are coming in, each holding firm their respective position.

Technically, despite today’s $1.59 rebound, it is too early to say that the market downward momentum has stopped. The market needs to close above the 2006 low of $54.86 to vindicate that $50.00 is the floor in the near term. If the market cannot stay above $54.00, it will again test and break the $50.00 support. The break of the $50.00 support is not an indication of any kind. What is telling about the market direction is whether there will be a follow-through. Here Crude Oil Market Analysis will quote an earlier analysis from Jan. 9 to end today’s analysis: “Today the market finally broke the 2006 low of $54.85 and had a follow-through selling of almost $1.00 to a low of $53.88. This $1.00 follow-through selling shows that the drop to $53.88 was not a normal panic selling triggered by stop-loss orders, but that there were new shorts coming in after the market broke the support. In other words, the market wanted to go lower.”

Strategy: Sell at $53.80 with a stop at $55.05; take profit below $51.00.

Dr. Chen