Despite Friday’s lower close for crude oil and refined products, the recent price appreciation has been impressive. Gasoline, in particular, has nearly doubled in price from its lows in November. Crude oil tested the low 30s three times between December 15th and February 15th, and has not looked back, after failing, on that third attempt, to achieve a break down below $30 per barrel.
The argument for these commodities (natural gas is a different story) to trade lower is alluring, if not compelling.
Inventories of crude oil are at the highest in more than a decade, and, with US refiners having engineered an impressive reduction in output, by running at very low rates, nationally, this overhang is not likely to be cleared overnight. Similarly, inventories of gasoline and distillate fuels (heating oil, diesel, jet fuel) are robust. Demand is also lackluster, although gasoline demand has risen to the low end of what is considered normal, recently.
With all this going for them, energy market bears wonder why such an obviously easy trade is not working out. The reason is that the ability to play this market from a purely fundamental perspective left the building long ago.
Over the years, crude oil and commodities, generally, have taken their place as an asset class along side bonds, equities, and foreign exchange. Recall that the last time crude oil inventories were this high was last June, just as oil soared to $147 per barrel; certainly, there was no shortage, and we now know that the recession was well under way.
We were, in fact, flying blind, economically.
Evidence of this asset class linkage was demonstrated with brutal clarity last Wednesday, when the Federal Reserve signaled its intent to engage in quantitative easing. This had the effect of putting the US mint’s printing press on turbo charge, and the commodities markets took notice – even natural gas seemed to catch a lift, briefly.
Printing dollars to this degree got inflation fears stoked. The dollar tanked on the news, and the inverse relationship that the value of the dollar has with energy played out, as well.
Other phenomenons outside the fundamentals also have worked to keep energy prices firm. The failed gilt auction in the UK and a less than overwhelming US auction the same day was unsettling. Yesterday’s US auction went better, thankfully. There was also the better than expected housing data and durable goods report, which gave further bolstering. While the weekly jobless claims report was horrific, investors seemed to look past this usually instructive energy market data point, as somewhat lagging. Let’s hope.
There is one significant bullish fundamental factor, if I may. OPEC output is down considerably, with Saudi Arabia, of all countries, leading the way by producing under their quota, while the above mentioned refinery curtailment is also a play by them to drain the supply swamp.
The comeback in prices has been impressive, and there are signs that a bottom has been put in across the markets. I point out that these are “futures” markets, and the severe monetary easing, which is meant to jump start consumption, feeds into a more bullish outlook for energy. Unfortunately, gone are the days when the pure fundamentals of supply and demand are eminently instructive.
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