Oil Myths and Why WTI Is A Short

by EconMatters, EconMatters.com

The Cushing Myth

John Kilduff, energy analyst with Again Capital, said –

“Going along with ‘drill, drill, drill‘ is now ‘ship, ship, ship‘. The bottleneck has been addressed in Cushing [Okla]. We’re seeing those inventories plunge. We’re seeing it from all the rail movement. It’s having an impact, as are the pipeline reversals.”

That is the rhetoric and here are the facts from the latest EIA report: Last year Cushing had 46.8 million barrels in storage and today Cushing has 47 Million barrels in storage. Thank goodness for all the rail and pipeline movements of the last year. I guess “plunging inventories” justifies the recent narrowing of the WTI-Brent spread from a year ago.

Funny Business Going on with Inventories

There was a 20 million withdrawal from inventories the last two weeks for the first time in 30 years. What are the odds that this is wholesalers stocking up for the rest of the summer? Expect a substantial build next week in inventories as Saudi Arabia’s upcoming increased export shipments finally hit the market, many wholesalers summer needs have been met, and product inventories are higher than this time last year.

2% GDP Economy

But the one thing that is apparent is that consumer demand for products didn’t all the sudden spike by a factor of 10 over the last two weeks. Furthermore, Oil inventories still stand at 374 million barrels compared to starting 2013 with 361 million in storage. This is after an unprecedented and highly unusual withdrawal occurrence that doesn’t fit with the 2% GDP growth environment that necessitates the Fed having to stimulate the economy with $85 Billion of monetary stimulus each month, and a total unemployment rate well above the 10% level.

Oil is Fungible

Oil is fungible, and with the emerging markets including China either in a recession or on the brink of a hard landing the Oil has to go somewhere as producing countries need to generate revenue from their primary resource for capital to support budgetary commitments.

The US is the strongest economy and the largest consumer of oil and petroleum products so with China cratering the global competition for oil revenue finds its way to flooding the US market with spare capacity. This brings the price of Brent down, and even if WTI is equal to Brent in terms on the spread, the abundance of Brent will pressure all grades of oil in general, and WTI in specific terms.

7.4 Million Level Reached

Because of the large draws in supplies the fact that US domestic production reached the 7.4 million barrels per day level with the latest EIA report went largely unnoticed. Once refiners revert back to lower capacity utilization rates where is this excess domestic production going to go? You guessed it straight into inventories as unlike the Saudi’s, the US just keeps producing oil regardless of seasonal demand.

Price started the year at $90, and we have 13 Million more barrels in storage Look for oil inventories to finish the year at higher levels than they started the year. Oil inventories are well above the five year range, and the remainder of 2013 will continue this historical trend of increasing levels of oil in storage facilities around the globe.

The Speculators just passed an Oil & Gas Tax

Gasoline prices have gained 30 cents in two weeks, and once futures prices are passed onto the consumer, expect the trend of the last four years to reemerge as every time prices reach the current levels, miraculously, the US economy slows down considerably. And why shouldn’t it as oil and the derivative products are the major input that makes all business and industry run. Therefore, a major increase in oil and gas prices acts as a major economic headwind for the economy.

Rinse & Repeat

The trend of the last four years is that speculators push the price of oil into the triple digits and gas prices to the $4 a gallon level, and the economic data and overall economy shows the impact of this new tax, causing a pullback in the economy. This cycle is followed by the speculators shorting oil back down to the low 80’s on economic concerns and building supplies with all the analysts citing a slowing China or increased domestic production as causes for the decline.

What is really at work here as not much has changed in the underlying fundamentals of the oil market in the last two weeks is pure and simple speculation. They run the price up as high as they can until consumers cry uncle or the governments brings out the SPR card, and then sell oil off hard in the opposite direction for at least 20 handles.

It is all about making money, and the oil market is one of the surest ways for speculators to make a fortune. They move the market up, collect their tax, then move it down, and collect the difference again. It is a nice scam, if the government lets them get away with it!

And being this isn’t an election year President Obama has been quiet as a mouse compared to last year when WTI crossed the 100 threshold he threatened speculators with an SPR release.

The Liquidation & Volatility Game

The overriding myth is that things are different this time, that somehow the fundamentals in the oil market have changed, nothing has changed, just a couple of months ago Longs were liquidated at $86 a barrel with the same level of oil and product inventories on hand.

The Downward Cycle is in the on deck circle warming up, and will be coming to bat soon in the Oil Market Speculation Game!