Option Investor

Hole In the Bucket

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This was the 8th consecutive week of declines in oil inventories with a monster 6.7 million barrel drop to 282.8 million barrels. The total loss for the last eight weeks comes to 32 million barrels and puts us 9.8% below last years levels. Is there a hole in that inventory bucket? You would have thought this would have propelled crude back to $100 but traders have a bear market mentality. Profits are being taken regardless of the sector and that includes oil.

The price of crude fell back below $93 on Friday as recession fears created worries of a demand slump. Gasoline inventories spiked +5.2 million barrels and the market reporters were all jabbering about the drop in gasoline demand. Unfortunately the facts don't bear that out. According to the EIA gasoline demand for the week ended 1/04/08 was 9.304 million barrels per day. That was up over 100,000 bpd from the same period in 2007 at 9.201 mbpd. Granted that is not a big growth spurt but it is still growth. We have seen demand decline due to the higher prices but it is still higher than 2007. The following chart from the EIA shows the demand patterns for 2006, 2007 and current. From my viewpoint they all look the same with a slight gain over the last three months.

The chart below shows the comparison in current crude inventories in red to the 5-year average in blue. You can clearly see we are approaching the bottom of the 5-year range at a nearly vertical drop. Crude prices will NOT continue to move lower if crude inventories continue to fall.

The EIA released their Short Term Energy Outlook (STEO) last week with forecasts through 2009. It was a laugh per page with their predictions of growth in supplies and declining prices. I won't bore you with all the details but you can go here for the particulars.

Basically they expect consumption to rise by 1.6 mbpd in both 2008 and 2009 compared to only a 1.0 mbpd increase in 2007. They expect "surplus" production capacity to grow from its current 2 mbpd to over 4 mbpd by the end of 2009. (Strange that nobody can find that 2 mbpd of surplus capacity today.) That excess capacity is kind of like Jimmy Stewarts invisible rabbit Harvey. Jimmy believed in him but the rest of the world thought he was crazy. The EIA believes in the excess capacity fable but the rest of the world thinks they are crazy.

After going to great lengths to explain where the additional production will come from they have a several sentence disclaimer about the pace and timing of supply growth being dependent on a myriad of factors. In the end they suggest "OPEC crude capacity could increase by 1.4 mbpd in 2008 and 1.0 mbpd in 2009." Without boring you I will leave you with four charts from the report.

I am going to contrast the EIA outlook with a view from a major market participant. Jeff Rubin is the Chief Economist for CIBC World Markets. CIBC and specifically Jeff is widely recognized for the breadth and quality of their economic research. CIBC views demand growth from Asia to be unstoppable and will have to expand by several magnitudes just to equal per capita consumption of South Korea.

Jeff was interviewed on CNBC on Thursday morning on Squawk Box and he probably felt like he was talking to second graders. I love Erin Burnett as a reporter but both she and Mark clearly had no grasp of the situation, as you will be able to tell from their questions. Jeff made a clear case for the coming oil problem and exactly as I have been detailing in my oil crisis reports. I think Jeff was trying to low key the headline for the segment of $150 oil within 5 years. If the scenario he lays out comes true the price will be a lot higher. He specifically says, "demand growth will be held to 1% for the next several years" by various factors. How will demand he constricted, by price of course because there will not be enough oil to go around. Prices will rise as countries compete for supplies and as the biggest consumer in the world the U.S. is going to pay the price. Just two years ago Jeff was predicting $100 oil and now he has raised that level to $150 but I believe he was downplaying to avoid being seen as even more of a lunatic than the reporters were portraying him. I am sure he has found that it is easier to lead people in $10-$20 increments to $200 oil over the next five years than make that leap all in one jump. As each increment is reached he simply raises the bar and adds another year.

Here is the interview from CNBC's Squawk Box from Jan-10th. It is available on the CNBC site as a streaming video as well.

Jeff Rubin, CIBC World Markets Chief Economist on $150 oil

We saw some major drops in some of our positions this week as the expected post 2007 profit taking finally took hold. Hopefully it is over but should we swing into a real bear market we will be closing some of the positions. I warned everyone going into year-end that I expected some profit taking and tax selling in early January and we would need to wait out these dips. So far it has been painful but not unbearable.

We got a real gift on Wednesday when Mosaic plunged from $100 to $80 and triggered our entry at $85. Before Friday's close it was back at $100. No complaints there!

Jim Brown

February Crude Futures Chart - Daily

February Natural Gas Futures Chart - Daily

February Gasoline Futures Chart - RBOB Daily


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