AS we have been saying watch the dollar for the next cue. After oil ending the week lower on a firming dollar oil prices are back on the upswing as the dollar weakens a bit in overnight trading. All of the other normal drivers will impact the market but the direction of the dollar continues to prove to be the most influential on the near term price of oil. There are several things working this week that could ultimately have a major impact on the direction of oil prices in addition to the ultimate direction of the dollar.
The most talked about upcoming event is the producer/consumer meeting in Saudi Arabia on Sunday, June 22nd. It looks like it is going to be attended by relatively high level players from producing countries, consuming countries, International Oil Companies, Wall Street Companies, IEA, EIA and I would guess anybody else who the Saudi’s think can help come up with a solution to high oil prices. For this week the impact on oil will revolve around the anticipation of the event.
Will Saudi Arabia increase production by 200 mbpd or 500 mbpd? Does the market actually need that additional oil and who is going to take it and where is it going to go? Lots of unanswered questions. The bottom line on this event is who or what is driving oil to historically high levels and can the current market be convinced in the near term that prices are overvalued? The Saudi’s (OPEC in general) along with most International oil companies & consuming nations believe the rise in prices is directly attributable to the speculators & investors. Saudi & OPEC have been jawboning the market for well over a year that the world is very well balanced in oil. If they truly believe that why are they talking about raising production so strongly? Likely trying to psychologically shake up the spec & investment sector in the market to release their grips on the long side of the market.
I find the concept of the meeting very interesting but I am very uncertain as to the impact the meeting will have over the medium to longer term. It may cap prices temporarily. If the meeting ends like most of these meetings (we saw the G-8 meeting end this way this weekend) with a joint statement that all participants agree the high price of oil is bad for the world and it must come down then not much of anything is going to change.
What really needs to be addressed is the real root cause of the problem.
· Worldwide demand growth has been outstripping supply growth for several years. The net result is a minimal amount of surplus crude oil capacity is now available to solve any and all of the potential problems that could arise. Problems like more violence and supply interruption in Nigeria, problems in the Middle East, natural disaster problems, etc. Surplus capacity is down to 1.4 million barrels per day (latest EIA Short term Energy Outlook Report) or only about 1.5% of demand coverage. Saudi Arabia seems to be the only OPEC country investing lots of dollars (about $50 billion) to bring on more surplus capacity. The first phase of that is just about available.
· The worlds commercial inventories, a second method of solving any and all of those possible supply interruptions has been trending down. At $135/bbl it takes a whole lot of working capital to keep oil in inventory. If prices stay high the concept of just in time inventory management will continue to be the modus operandi. Governments need to build more Strategic Petroleum Reserves as quickly as possible (not stop filling like politicians demanded in the US). The more oil in SPR’s around the world the less anxiety over possible supply disruption. The consuming world should take as much extra oil as Saudi Arabia is willing to make available and increase the SPR wherever feasible around the world.
· Believe it or not the high oil price environment is turning out to be a very good thing as elasticity of demand is starting to take hold in the US and other developed nations. In fact in the latest IEA oil market report shows OECD countries are expected to consume less oil in 2008 than in 2007. As of now the only growth areas are in the developing world led by China. High prices will help get the medium and longer term fundamentals more balanced as the world works to bring more oil on stream.
· A weak US dollar (the oil currency) is bad for oil. A weak dollar causes non-dollar denominated countries to not truly experience the high oil price environment and results in keeping demand above where it should be at the current dollar price. Weak dollar translates to undervalued oil prices in local currencies. A firming of the US dollar will go a long way to capping the high oil price environment in the near term much more so than the meeting of who’s who in Saudi Arabia. It is time for the US to raise interest rates and for the Treasury to begin a program of dollar intervention (buying)
The above simplified list has been with us for several years. The situation has caused the energy market to be very nervous and concerned about what happens when the next problem occurs like another hurricane, or Geopolitical event. The result is what I like to call insurance buying or fear leading the market higher. Yes there is speculation in the market, yes there are more players investing in the oil complex as it has been the best place to place money from a return point of view. Yes there are also non-speculators buying oil at high prices. However, as shown in the following chart of the net non-commercial (speculators) position for the three main oil futures contracts on the Nymex the net long position of this group of participants is now well below where it was at the end of last year and yet the price of WTI is up over 40% year to date. Sure indicates to me that there is more to the high price of oil beside the speculators.
Speculators & investors do not seem to me to be the cause of the high oil price environment but rather a symptom, a very profitable symptom at that. The 4 main points discussed above are the cause and will remain the cause. We are clearly in a demand driven model environment for oil and will remain in this environment until the world:
· Reduces consumption
· Increases available supply/surplus capacity, Saudi Arabia investing in surplus capacity
· Build Strategic Oil reserves further from current levels
· Finds more oil...drill everywhere safely
· Continue to add more alternative fuels to the mix.
If the world commits to a unified program covering the above solutions with sincerity and not for political gains the energy complex will begin to ease and ultimately if the above is successful over the next 3 to 5 years energy prices around the world will begin trading at significantly lower levels. Remember this situation began in the early 70’s so it is not going to go away next week.
Currently prices are higher as the dollar weakens from last week’s strong levels.
| Current Expected Trading Range | | | ||
| | 6/16/08 | Change | Upper | Lower |
| | | From | Resistance | Support |
| | 7:19 AM | Yesterday | | |
| Jul WTI | $135.21 | $0.35 | $140.00 | $99.20 |
| July HO | $3.8598 | $0.0230 | $4.0000 | $2.7100 |
| July RBOB | $3.4746 | $0.0120 | $3.5000 | $2.5200 |
| July NG | $12.709 | $0.084 | $13.000 | $11.000 |
| | | | | |
| Euro/$ | 1.5461 | 0.0111 | 1.6000 | 1.5200 |
| Yen/$ | 0.9237 | (0.0005) | 1.0450 | 0.9000 |
Dominick A. Chirichella
Energy Management Institute
tel 646-202-1433
tel 845.368.3904
fax 801.383.7510
www.advancedenergycommerce.com
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