Drillers Bullish on Oil?

Source: VantagePoint Intermarket Analysis Software

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When market analysts are trying to evaluate potential trades or investments, they often start with the value of the U.S. dollar because of its central role in world trade. And one of the centerpieces in analyzing the interconnected world markets is oil.

In the last few weeks, crude oil futures have moved above the upper boundary of a trading range (red dash lines) at $50 a barrel but have struggled to stay there as figures for U.S. stocks of oil and energy products usually seem to come out on the high side while demand remains on the low side during the economic recession. Crude oil futures did show a medium-term moving average crossover on the VantagePoint chart (red circle) after the triple bottom on February 20, but the outlook for crude oil prices is not very clear.

One of the well-established axioms about markets is that the solution to low prices is low prices (and vice versa for high prices) – that is, when prices get too low, supply will begin to diminish until it reaches a level that will cause buyers to become more active again. Global crude oil supplies have been reduced as the Organization of Petroleum Exporting Countries has cut its production quotas, and domestic production has declined as drillers have shut down wells and refiners have scaled back their processing activities. But demand has not picked up yet, and the price balance between supply and demand seems to be in the $40 to low $50 a barrel range.

At some point supply will get low enough and demand high enough to increase oil prices and encourage oil producers to pick up their output. One clue as to how these companies might view the outlook can be seen in the price of their shares. Schlumberger is an example.

Source: VantagePoint Intermarket Analysis Software
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While crude oil futures have slipped back from highs above $54, Schlumberger provided a predicted moving average crossover to the upside (red circle), VantagePoint’s predicted moving average differences are pointed up (red arrow) and prices popped above the previous highs (red dashed line) to the highest level since last November. It costs millions of dollars to provide the equipment and facilities to bring oil wells into production so one would have to assume that investors in oil drillers must be optimistic about oil higher prices to push share values up.

But unless you follow the oil industry closely, you might not know which companies would benefit most from higher oil prices. Although they are interrelated, each company has its own set of issues such as debt to service, cost of production, etc. Instead of putting all of your bets on one or two companies, you might want to look at the Oil Services HLDRs exchange-traded fund (OIH).

Source: VantagePoint Intermarket Analysis Software
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As the VantagePoint chart illustrates, after seeing the crude oil futures upside predicted moving average crossover of Feb. 20, OIH followed with its own upside moving average crossover on March 6 (left red circle) as VantagePoint’s predicted moving average differences angled upward (left arrow). After a correction, OIH recorded another predicted moving average crossover (right circle), rising predicted moving average difference lines (right arrow) and a move above its previous highs (red dashed line).

It’s always hard to make definitive conclusions in a market as volatile as crude oil, which may move $2 or $3 or $5 up or down in a day, but the evidence from analyzing these charts suggests that those who should know the market the best – the oil services companies – think that crude oil futures prices should head higher in the future, something oil traders may want to note.