Kilduff: Finishing Below $60 - What It Really Means
Crude oil prices finished the weekjust below the psychologically damaging level of $60 per barrel. As prices marched higher all week, howls went up from fundamental traders and commercial interests decrying the disconnect between abundant supply levels, the poor demand outlook, and high prices. As I mentioned in a recent blog, attempting to discern future price direction from basic supply and demand data has not served investors all that well for several years now.
Energy prices have been keying off the relative rebound in sentiment that has engulfed the entire market. As the equity markets have rebounded, so have energy prices. One commentator remarked this morning that “less bad is the new good.” Ain’t that the truth! To think that some solace can be taken from a nearly 9% unemployment rate, with a loss of another 539,000 jobs, is a sign of the times. While banks need billions more to shore up their balance sheets, they apparently needed billions less than we feared -- more good news.
Venezuela also continues to do its part to get prices on the move higher. Not with greater adherence to their OPEC quota, rather by making their investment climate all the more uncertain. 60 oil services companies were taken over by the government of Venezuela, including assets of the US based natural gas company Williams. This comes on the heels of last year’s expropriation of oil assets from several major oil companies, including ExxonMobil and Conoco Philips. With policies like these, Venezuela will be increasingly challenged to attract the investment and intellectual capital necessary to maintain or increase output levels.
The production response to the slump in prices has been impressive, even as global inventories have built considerably. This inventory build was enabled by the much higher values being fetched by crude oil and refined products for delivery in nine or more months hence. That play has ebbed somewhat, recently, though. On the production side, Saudi Arabia has been the cutter-in-chief, in terms oil output reductions. Less heralded, however, has been the persistently low level of US refinery operating rates, which have hovered in the low 80% range, dating back to last year’s hurricane season.
Last year, during the epic run to $147 per barrel, there was concern about a lack of spare production capacity and a deficit of oil production in relation to demand. Today, there is an incredible surplus of spare capacity, which continues to grow. The rise in prices belies this fact, and instead appears to be calculating a return to last summer’s conditions.
The question is: will it last? This week’s rally in gasoline may be enough to quickly generate a $2.50 national average at the pump, which certainly represent another drag on the consumer – both in terms actual out-of-pocket and psychologically. Inventory levels are down and industrial companies that I speak to tell me that orders have picked up. I am also getting very positive reports out of China that demand is actually strong for basic materials.
In the short-run, this rally looks to have legs. $60 seems inevitable at this point, and will likely come early next week. Due to the way this market has absorbed the cadence of grim economic data, it is difficult to conclude otherwise. It is uncomfortable for me to be so discarding of the fundamentals, and they have a way of usually winning out in the end. The rally has been impressive and long. It may have more left in it, but it’s hard to see it having much more. Another opportunity to get long energy should present itself, again, relatively soon. If you caught this move, congratulations, and book those profits.
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John P. Kilduff Senior Vice President Of Energy at MF Global Ltd. He's also a CNBC contributor.