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The energy complex managed an impressive recovery bounce off the early December low, and part of that bounce was attributed to the latest OPEC production cut promises, but perhaps an even larger portion of the recovery action was the result of the noted slide in the US Dollar. In the background, year over year US crude oil stocks have risen by 26.4 million barrels, while weekly gasoline demand have continued to plummet versus year ago levels. In fact, a private survey by Mastercard recently suggested that retail gasoline purchases showed a 5.4% decline in the latest week versus year ago levels, and that clearly suggests that so far the sharply lower retail pricing has yet to resurrect demand at the pump. Certainly OPEC is attempting to circle the wagons and reduce output within the cartel (and it has also attempted to secure reduced output from Non-OPEC producers), but at the current rate of demand destruction, it just doesn’t seem like the oil producers have reigned in their supply enough. In fact, in addition to the sharp fall off in US economic readings, we are also concerned that floating supplies are building, and that in turn suggests thatOPEC hasn’t been able to hide its lack of compliance and/or that the amount of demand loss has simply overwhelmed its efforts to reduce supply.
The International Energy Agency has reported that the combination of rising physical supply and declining freight rates has already resulted sharp rise in the amount of oil being put into floating storage. According various private sources, anywhere from 26 million barrels to 50 million barrels of oil have been booked recently, and that clearly points to the prospect of an expanding surplus. With the US refinery operating rate in the latest weekly oil inventory report falling to just 84.2% of capacity, a full 3.7% below a year ago levels, the rate of burn for crude oil supplies in the US continues to decline.
The recent COT report showed the speculators in the US crude oil market to be net long 127,000 contracts (as of December 9th). With the February crude oil futures last week reaching $8.30 a barrel above the level where the COT report was measured, the spec long position was probably puffed up to an even more pronounced level.
With the head of the EIA predicting that oil prices could fall below $30 a barrel in the next few months, it would seem like credible players still think that oil prices have the capacity to see significant downside ahead. In our opinion, it could require significant declines in futures prices and then a significant decline in retail prices before one can expect to see a leveling out of the demand destruction pattern, especially since recent credit card monitoring reports specifically pointed out that despite lower prices, the overall volume of credit card sales of gasoline remained in a downtrend.Even though we have posted the enclosed chart on the cost of various energy sources in prior newsletters, we think that the information within that chart is extremely important in attempting to determine where one might even begin to predict some form of equilibrium bottom in oil prices. The chart highlights what could become a particularly important price break for crude oil just under the $37 to $39 per barrel zone. In fact, seeing benchmark crude oil prices below $37 for a sustainable period of time could reduce the amount of Non OPEC oil supply and in some cases reduce output from inside OPEC. Therefore, we continue to see a downside target in February crude oil of $38 unless there is some form of improvement in the economy. If short term supplies continue to build and the global economy worsens, oil prices could end up falling below our estimated equilibrium point!