Oils Slippery Slope
Research for Online Investors

by John Dalt

5/20/10

Crude oil, as represented by the USO etf, has been on a slide since hitting a high of $42.19 on April 6th.  USO is trading at $32 and change today.  This is a 23% decline in the last six weeks.  What has happened in the oil patch to cause the decline?  We have had increasing inventories, but is the build in inventory responsible for the price decline?

The answer is, No.  Inventories have been slowly building. Domestic production is up 200 thousand barrels per day during the last month over one year ago levels.  Imports are up 400 thousand barrels per day over last year.  Our economy is improving, if we look at how much crude oil refineries are purchasing.  Refinery inputs are 400 thousand barrels per day higher than last year.

U.S. inventory is actually lower than last year when we look at the “days of supply.”  This considers the amount of inventory divided by the daily usage.  Even with our higher inventory, we currently have 24 days of supply compared to 25.6 last year.

U.S. crude oil inventory is 362.7 million barrels as of last week.  One year ago, inventory stood at 368.5 million barrels.  Last year was higher than the top of the five year average range.  This range is from 320 to 355 million barrels.  This tells us we are above the five year average range, but we must remember three of those years were before $145 dollar per barrel oil destroyed demand and the credit crisis that slowed economic activity.

We like to watch this chart, as it visually shows us where our inventory is compared to the average band width.  It also shows us the trajectory of the our week-to-week inventory.  We can pick up the decline that should begin in inventories from the average band.  This would coincide with the beginning of summer driving season.

The last two summers have not seen a significant increase in gasoline usage.  High prices in the summer of 2008 and economic concerns last summer kept people at home.

Gasoline stocks were down 300 thousand barrels last week, and distillates (diesel fuel) were down one million barrels.  Drivers will be encouraged at the pump as prices for both fuels have been trending lower with the price of crude oil.

As we pointed out before, crude oil can move anywhere in the world with a phone call.  While it is priced in dollars, currency fluctuations have much to do with the present pricing in dollars.  The Euro has fallen against the dollar 7.7% since April 6th, when oil hit its high.

Crude oil is cheaper in Europe, but has not fallen as much as it has in the U.S.  Buyers must consider local currency valuation to dollars when paying for crude oil.  We see crude oil as oversold and undervalued at current levels.  There is plentiful supply worldwide, but recovering economies require more energy.

U.S. dollars were available at low interest rates to use for a carry trade.  Traders could borrow dollars cheaply and buy crude oil on ships or on the futures market.  A stable or falling dollar made this possible and profitable.  The falling euro has pressured these traders to close their positions as the dollar moved higher.  This forced selling has squeezed the price of oil, forcing it lower with immediate supply, or contracts for future supply, outstripping demand.

One has to be careful trading against ‘smart money’  The smart money mentioned here is the big money playing a dollar / crude oil carry trade.  Smart money has to pull away from a trade that is moving against them, and may be presenting an opportunity for the average investor.

For short and long term gains look to the USO etf.  It is oversold, and we are coming into the summer driving season.  Americans are more comfortable that the economic recovery is intact, so they should take advantage of summer travel after two years of staying home.  The same economic recovery we see in the U.S. will drive demand for more energy worldwide in the future.  Disposable income means purchase of new cars, resulting in more gasoline use.

The market is in a full scale sell-off.  My advice to friends and subscribers is to relax.  Buy companies if you can't ignore the wonderful price being offered, then go on vacation.  This to shall pass.  We expect a a bounce as the market is oversold.  We don't know if a low has been put in, but the economy is growing and companies are making profits.  Profitable companies pay dividends, or eventually command a higher price for their stock as it represents the assets that are generated from the profits.

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have he ld a position in a security earlier, or in the future.

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