Posts Tagged ‘Oil’

After a move from $40 to $50, it looked like oil may have bottomed. We now stand at $38, even after production cuts from OPEC.

Oil extended yesterday’s 8.1 percent decline after OPEC agreed the group’s 11 members with quotas will trim current production by 2.46 million barrels a day to 24.845 million barrels a day. U.S. fuel consumption in November declined 7.4 percent from a year earlier to the lowest for the month since 1998, the American Petroleum Institute said yesterday.

The media describes this as “traders thinking the cuts won’t be enough to eliminate a supply glut.” I don’t necessarily agree with that since it isn’t plausible to say that cutting aggregate output from 87.5 million barrels a day to 81.5 wouldn’t affect the price…there lies the issue. It’s not that the action won’t be enough to boost prices, its that OPEC can’t afford to/doesn’t have the discipline to cut output that drastically since they are having a credit crisis of their own, and oil is the only thing the middle east exports (How else will they finance all of these underground malls?)

Anyway, if you believe oil will sustain these lower price levels for the immediate future, there is no explanation for oil related companies to sustain the rallys they had when oil seemed to have bottomed at $40. The drillers (Schlumberger, Transocean, Haliburton) are still depressed, but the conglomerate companies like Exxon and Chevron are quite high.


“USO” is an ETF which tracks the price of crude, “XOM” is Exxon, and “CVX” is Chevron (a company which does the same thing as Exxon). Notice that during the sell off in October, both of these companies dropped at faster rates than crude oil. We see the divergence since then,  however during the sell off in November, we saw the same behavior as the October sell off – the oil companies falling harder than oil itself. Given this increasingly large gap in the past month, I don’t think it’s unreasonable to conclude that Exxon and Chevron will be hit rather hard during the next sell off in the new year.

Therefore if you think this rally will end in January, consider buying “DUG” a 200% short ETF which targets oil companies like Chevron and Exxon, or “EEV” which shorts the MSCI emerging markets index. Emerging market economies rely heavily on oil prices, however the Obama infrastructure plan ignited a rally amongst the Iron-ore companies (iron-ore is the chief ingredient in making steel), which caused this ETF to go down substantially.

Or if you don’t like financials either, there is “SDS” which is the inverse of the S&P 500. Since the S&P is a weighted-average index, moves in Exxon and Chevron (in addition to financials) typically dictate how the S&P will close (since they have the most weight from their share price multiplied by outstanding shares – or market caps).


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As a follow up to my prior post, here’s an interesting chart (courtesy of Fitch Ratings) from Paul Kedrosky’s Infectious Greed:

be-oilprices_2Interesting stuff. I never realized the variance in costs of oil extraction – notice Bahrain is currently underwater for every barrel they sell..

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The WSJ has a good article in Monday’s paper talking about the dwindling short term prospects of industries in the renewable energy sector:

“The sudden reversal in crude prices has removed — at least temporarily — a key rationale for investors to pump billions of dollars into alternative fuels, industry analysts say.”

With the demise of Lehman Brothers and AIG, two of the biggest lenders in the renewable energy sector, wind farm developers find themselves short of liquidity.

“The credit crunch deals a negative blow to the whole [wind] sector because it’s heavily dependent on debt financing,”

The extension of tax breaks from the rescue plan (yeah, there were a lot of things in there you probably didn’t know about. Look up the provision about arrow heads) will be beneficial, but it is becoming more clear that private investment may not prop up the future of the industry with tight credit and $70 oil (with energy prices at these levels, alternative energy isn’t cost effective in an immediate time frame). This is why peak oil enthusiasts cringe when oil drops below the $100 mark; the investment in wind and solar energy will likely be deferred to a later time, probably when it is too late. Of course the peak oil quire was more forceful when crude traded at $145 a barrel, but many of these very same members are now the people who buy into the notion of “demand destruction” (This is the Wall Street sheep mentality and its effect on the markets I constantly allude to). We had a pretty rude awakening of what life is like when gas is $4.50 per gallon, and a more pertinent realization about long term sustainability – houses which are 50 miles away from a major city with no rail system are worth much less, meaning less collateral to borrow against to pay for things (at least that’s how it would work if you could still borrow against your house).

While important, this issue is not one which takes precedence; our human capital is put to much better use in diagnosing our financial crisis. Why, might you ask, can we disregard the proper planning? Because the security of alternative energy’s future is pretty simply dealt with; Unlike the credit crisis, it’s clear what  will happen when you throw money at the problem – how do you think oil companies got so big? Should Obama land in office, we would likely see an increase in spending on governmental programs, like we do with most democrats, and much like we saw under FDR. If this doesn’t happen, we’ll likely have a lost decade in terms of developing technology for alternative energy. We witnessed this at the end of the United States’ stagflationary period in the early 80’s, when all of the energy conservation tactics were almost instantaneously scrapped. But I’m not worried – I don’t think that we’re stupid enough to do that again.

***Something very relevant: read this article about the relationship between low oil prices and deflation.***

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I have to first congratulate my old economics professor for nailing the root of the dollar’s weakness in a prior post:

The US economy, rightly, faltered first – With no fiscal policy upon which to draw, Bernanke got it all with not even a blindfold to keep him company. Rates were slashed, time and again. Meanwhile, the UK, Europe and any number of other economies were (i) not faltering, yet, but as importantly (ii) more concerned with inflation which, while still measured dodgily and with political expedience in mind, is nevertheless still measured more accurately, and taken more seriously, everywhere better than in or by the US…Thus my argument. The US dollar is not appreciating in value because it is normalising upward: it is appreciating because the rest of us are normalising downwards.

That was written before the Fannie & Freddie bailout (he doesn’t live in the US, which is why he speaks from a European perspective). If he had an adjusting entry, it may have added an analysis not unlike mine:

1) Suddenly, the prospects of serious inflation are back; this time, not driven by expensive commodities, but by high rates of growth in the money supply…Think of the market for the dollar like a stock: the value of the dollar is driven by factors of supply and demand. However, what happens when a company holds another stock offering…Using Merrill Lynch as an example, they dilute their shares and make each share in the company worth less than before. Adding more dollars into the economy would effectively be the same as a company diluting their share base. When there is more of something, it does not have the same purchasing power/value as before.

The unprecedented $25 rise in oil today is pegged directly to the weakness of the dollar…hmm.

Doesn’t this seem a little strange? Today officially marks the first week of the SEC’s action to ban the short selling of virtually every financial institution, and we see a flood of money going back into the commodity realm. One explanation is the most sensible investment was eliminated (shorting financials), so the market was left to find somewhere else to invest.

  • Retail has already had a run out of its element as a play against falling oil, so that’s out.
  • Technology is the first expense businesses will cut in bad times, so that doesn’t work either.
  • Autos and Airlines? Ha
  • Financials? Well they just rallied 20% in two days, and now they’re selling off.
  • Commodities? Of course. Oil has fallen 35%, and the dollar will be weaker than we thought, in a United States with a $1.1 trillion budget deficit.

This is when the “Free market” guys look really smart; the government came in, made an enormous intervention, enforced new regulations which limit our flexibility, and ultimately caused more problems (at least for now).

I think the only good way to look at the ban, is it provided Morgan Stanley and Goldman Sachs time to become holding banks. Now that they have a deposit base (the FED, and any commercial bank they choose to acquire), their business structure is no longer flawed, and bearish investors will have a much harder time justifying shorting these guys to oblivion.

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August 13th:

I’ll be starting class again soon, so I’m not sure how much blogging I’ll do going forward (barring anything fun to write about).

This will be one of my last posts before school, and I think this is a good time to write what I’ve been feeling about the markets for a while.

Well, the Olympics have begun and oil is down 22% from its all time high. (The timing of my prediction was right, but my reasoning was incorrect…I guess its better to be lucky than good)

As one would expect, this was welcomed with open arms (the consumer may be saved from demand destruction, the Fed can keep rates at 2%). The rotation out of all things pertaining to commodities (oil, agriculture, metals) have provided an interesting situation: there is now nowhere left to hide, and there is nothing which is untouchable from the downward trend of the broader market. In other words, there are no bullish “momentum” stocks to park your money in, as all of those have gone into free fall at one point or another, and have since stabilized at a lower price. At the same time however, because of the fall in oil, there have been some unfounded gains in certain places (chiefly anything financial), until today!

If you notice from the chart, financials have sort of, drifted higher recently. The rally which occurred after the bottom on July 15th was sustained because of the simultaneous drop in oil…The only thing is that, some day oil will also stop falling, and will stabilize. Many say that will happen at $110/barrel. I think that is a sound prediction, but believe that it can be around $85-$95 through the winter. Winter is 4 months away though, and once oil stabilizes, the hot money has to go somewhere. More importantly, there won’t be anything fueling the rally in financial services, because they are still in horrendous shape.

Finally, the prediction….

I think the saying “markets do not repeat themselves, but they rhyme.” applies to our current situation. In case you have repressed this information (I did, until today) the last sell off in financials was sparked by none other than a series of downgrades…on Tuesday, we had another round of downgrades and cuts in earnings estimates (Goldman, JP Morgan, Morgan Stanley).

While we do not have as negative a catalyst such as rising oil prices, we do have, what I believe to be a drying pipeline for good news now that commodities have dropped big. This also means that Financials are in the spotlight because they can no longer share the blame of a bad environment with high oil prices. TO TOP IT OFF, a more severe catalyst for financial services can emerge, and that is the deterioration of banks like JP Morgan, which have been virtually unscathed…until Tuesday. If they were believed to be the fortress from this whole mess, and they come out in bad shape through 2009 (which was picked up by their press release, hence the biggest drop in 6 years) we can see a serious sell off.

Finally, by now we must know that the news of Merrill Lynch selling their CDO’s was a bad sign, not good, and John Thain might go down as one of the worst CEO’s in finance history because of it. Not only did he sell the pre-2006/2007 CDO’s – which represent the better quality basket simply because debt from that time frame is more likely to get paid back – but the good CDO’s within that tranche were undoubtedly cherry-picked by the guys who bought them. (Honestly: if you were spending billions of dollars on such a toxic investment, wouldn’t you make sure you got the best ones?)

The inevitable realization of losses in Level-3 assets/off balance sheet assets, coupled with instability amongst the bulge bracket banks, will result in another sell off, and another bottom (no one can really say if it will be worse than the last one, and I surely won’t begin to speculate)

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I didn’t want to write anything, because I was afraid of jinxing the drop in crude:


To cover myself In defense of this happening tomorrow or next week, I’ll have to site Jim Cramer, (by doing that, I’m definitely marking the end of this pull back) He says a typical bear market rally lasts 3 days, and if the inverse relationship between equities and oil continues, then I won’t be off the hook (I don’t know where he got that number, but then again I don’t know how he concluded that natural gas should track oil at a pricing ratio of 1:6…maybe by historical averages?).

The interesting thing about looking at oil futures further out into the winter, is that the slope of the prices is still slightly upward (as I write this, its $129.50 a barrel, and is around $135 for March) …that seems pretty rudimentary, but the way I interpret that information is that the market views this development in crude as a mere pullback, and only that.

One must say though, the fundamentals for $145 oil have to be starting to come into question…I think since it is still the “summer driving season” (as if people use less oil in the winter…who heats their house anyway?) we could expect another testing of $150 before a more sustained correction.

On a related note, a colleague of mine had actually heard about the theory that Oil should come back after the Olympics are over, supposedly because the Chinese have been hoarding oil in preparation for all of this activity (the mindset being that they didn’t want to look stupid by having an energy crisis in the middle of their renaissance)…naturally the hoarding should stop when they no longer need to do so.

On an unrelated note, I saw Mike Bloomberg at the Billy Joel concert last night…he was surrounded by security guards, but I think I saw him signing an autograph…He looks exactly the same as he does on TV.

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Finally some mercy in the hard/soft commodity market:

  • BRENT CRUDE FUTR:     $141.50     -2.02% 11:10 AM
  • NATURAL GAS FUTR:     $13.03       4.05% 11:10 AM
  • CORN FUTURE:               $747.00     -3.86% 11:25 AM
  • SOY BEAN FUTURE:        $1561.00    -4.29% 11:29 AM
  • WHEAT FUTRURE:           $836.00      -5.77% 11:30AM

A couple of factors have spurred the pullback today, including some profit taking following speculation that Iran is going to be attacked. I think the true fundamentals lie in this exerpt:

The fewest Americans in three years likely traveled over the July 4th weekend as record gasoline prices and a slowing economy forced consumers to curtail spending, according to AAA, the largest U.S. motoring group. The number of people taking trips of at least 50 miles (80 kilometers) from home over the holiday weekend will fall 1.3 percent to 40.5 million, AAA said.

Things may come back to reality for a while now that the United States is exhibiting stagnating demand, and China should have a let down in demand once the Olympics begin…I realize I continue to stress this point, but if there is anything that can alter a country’s short term demand, it is the Olympics. Whether its cleaning algae, or restricting traffic to curb pollution, they have devoted a tremendous amount of energy and resources in preparation for this event…The place is a complete disaster:

“About 10,000 people are scooping algae out of the sea at the eastern city of Qingdao, while officials in Inner Mongolia are preparing to fight off a plague of locusts that may arrive in the capital city during the Olympics”.


“The city has spent 120 billion yuan ($17 billion) on measures to improve air quality and will take half the cars off its roads and halt construction from July 20 in a bid to reduce the threat to athletes from competing in smog”.


“Security is among the top concerns for China and, according to officials, is the main reason why the organizing committee’s budget rose 25 percent to $2 billion”.

We’ll have to wait and see…In the meantime, I cannot imagine a long term allocation of capital to these kinds of expenses.

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