Crude Oil Market Analysis (1/23/07)

“I have yet begun to fight.” –John Paul Jones

Today is another day of heavy fighting between the bulls and the bears. As Crude Oil Market Analysis (“COMA”) observed on Jan. 19, “all these factors contribute to a battleground for the bulls and bears at $46.20-$54.86…. 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.”

“Volatile it is, indeed.” Master Yoda would speak in this reverse fashion. Yesterday the market dropped from $54.65 to $52.07 for $2.58 in three hours. Today the market slowly rose from the overnight low of $52.41 and rallied from $53.64 to a high of $55.15 for $1.51 in the last half hour of trading before closing at $55.04, leaving the day’s range as $2.74.

Yesterday COMA forecast a downward market movement if the market would stay below $53.10 and a range-bound day if the market would stay above $53.10. But the COMA forecast was wrong. However, COMA offers no apology but only apologia because COMA could not have forecast that the U.S. Energy Secretary Samuel Bodman would make the announcement that the U.S. will expand its SPR by 1.5 billion barrels in the next 20 years—the market heard the “1.5 billion barrels” but not the “20 years”—by injecting 100,000 barrels per day to the SPR starting in the spring until the initial installment of 11 million barrels are added to the SPR. (If COMA had been able to make the forecast of the announcement, very soon the COMA would be published from a slammer.) After the announcement the market immediately jumped $1.51 in half an hour.

Yesterday the bulls initially pounded the bears until the bulls ran out of steam at $54.65, and then the bears beat back the bulls for $2.58. Today the bulls came back again—not with a vengeance because they themselves could only push the market to a high of $53.93. As COMA forecast on Jan. 19, “if the market cannot stay above $54.00, it will again test and break the $50.00 support.” Just as the bears were about to show the bulls the path to $50.00, Secretary Bodman became the bulls’ deus ex machina as the final arbiter of the market and gave the market just a little push to above $54.00. Once the market went above $54.00, the bears finally relented and retreated. The ensuing short-covering rally resulted in a one-day gain of $2.46, the biggest one-day gain since Sept. 19, 2005 when the market rallied $4.39 in one day.

Although COMA stated on Jan. 19 that “the market needs to close above the 2006 low of $54.86 to vindicate that $50.00 is the floor in the near term,” today’s market rally has little implication by itself.

Today’s rally is mostly technically driven triggered by an event that has little fundamental basis. Today’s market is technically driven because as COMA observed on Jan. 19, when the new longs are coming in while the old shorts refuse to give in, once the dam breaks, in either direction, the flood will run further than it would do from a natural lake.

However, the event that triggered the dam breaking has little fundamental backup. First of all, the DOE will take away only 100,000 barrels per day from the market, which is less than 0.5% of the daily U.S. demand, and this quantity of oil can be easily supplied by the U.S. ally Saudi Arabia, now that Saudi Arabia has more spare capacity than before as it implements production cut. And the market knows this, as reflected by the fact that although the March 2007 contract rallied by $2.46, the contract for December 2012, when the U.S. still needs to fill its SPR, rose only a nominal $0.89. Politically, as the campaign for the 2008 presidential election gets under way, the Administration, which includes the DOE, will be very sensitive about antagonizing voters with gasoline price hike caused by rising oil prices.

In the short term the market becomes difficult to forecast, because it has little direction as the bulls and bears sort themselves out in the next couple of weeks.

Tomorrow’s DOE report also becomes difficult to forecast.
Crude oil’s refinery input will likely continue to drop to 14.9 million barrels per day as refineries continue to shut down for maintenance. The crude import will drop from last week’s 11.1 million barrels per day to 10.0-10.5 million barrels per day, but this is a big range that may result in a crude build of 0.2-3.5 million barrels. Such a forecast has no meaning.

Gasoline production will also drop from 9.1 million barrels per day to 8.9 million barrels per day due to the reduced refinery turnaround. Such a drop will be matched by a drop in demand from 9.06 million barrels per day to below 9.0 million barrels per day as motorists are snowed in by the bad weather. Whether or not gasoline stock will build depends on the import level, which is difficult to forecast. If the import stays above 1.0 million barrels per day as it has been in the last two weeks, the gasoline stock will likely build by the Wall Street estimated 1.2-1.5 million barrels.

Distillate production will also drop from last weeks 4.0 million barrels per day to 3.9 million barrels per day due to refinery turnaround. Such a drop will be compensated by a rebound in import from last week’s 277,000 barrels per day to a more seasonal level of over 350,000 barrels per day. Demand will pick up from last week’s 3.98 million barrels per day to above 4.1 million barrels per day due to the cold weather. Thus, the overall net effect on distillate stock will be a draw, but the quantity depends on how much the increased import can compensate the reduced production and increased demand.

Yesterday’s COMA already expressed some vague concern that the market may start to rebound, as it stated the opinion that “it is not that the fundamentals justify the market’s drop to $50.00, but it is that the market wants to go there.” As a result, COMA moved down the stop price by 85 cents from $55.05 to $54.20. As today’s market action demonstrated, once the market touched $54.20, it went on to rally another 95 cents and never dropped back.

Result of previous trade: Short at $53.80 established on Jan. 22 was stopped out at $54.20 for a $0.40 loss.

Strategy: Sit tight until the release of the DOE report.

Dr. Chen