Bears Coming Out On Oil Prices

Jim Brown
 
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With crude oil and refined products hitting a 20-year high last week the bears are starting to come out of the forest.

Lawrence Eagles, and analyst at JP Morgan said they see both lower prices and a tighter range ahead but the risks are increasing. He blames the deteriorating global economic outlook and weakening OPEC discipline and cautions prices could dip as low as $50 within the next 12 months.

He said, "if demand drops the Gulf Trio of Saudi Arabia, Kuwait and the UAE are likely to demand cuts from the "leaky" OPEC members in order to rebalance the market." Getting those cuts is going to be a challenge since OPEC members have been cheating so long that they have become dependent on the cash flow. The 2008 production cut of 4.5 mbpd only has a 52% compliance rate today. That means actual production cuts today are only 2.34 mbpd. That is an extra two million barrels per day on the market over and above OPEC's stated production levels.

Last month JPM cut its forecast for crude by 5.5% to $77.25 per barrel and they are probably going to cut it again soon. They also lowered their 2011 forecast from $90 to $79.25. If the economy continues to weaken all those forecasts are going to be way too high.

Crude has been locked in a broad $70-$80 range and a level where OPEC has grown complacent. With prices today closing in on $70 again they are about to have a rude awakening. China's oil demand fell by -5.6% in July according to numbers released last week. This is a direct result of the government's efforts to slow the economy. Europe, with the exception of Germany, is flat economically with the debt ridden southern countries falling back into recession and dragging down the others with marginal growth. The U.S. is clearly in decline as evidenced by the recent reports. This is not a recipe for rising crude demand.

Hedge funds cut bullish bets on gasoline by the most since 2006. Funds cut long positions on gasoline by 74% in the week ended August 17th. Net long contracts declined from 28.940 to only 10,219. That is the most since October 2006 according to the CFTC. Gasoline prices have declined -21% since the high of $2.4351 on May 3rd.

Gasoline demand rose +1.7% in the prior week according to the MasterCard Spending Pulse report. This was attributed to back to school shopping and families trying to squeeze in one last trip before school resumed. Gasoline supplies have risen seven of the last eight weeks and +2.7% since the end of June. This is the first time since 1990 that gasoline inventories have peaked in August. They typically peak in June or July.

Funds cut net longs in heating oil by -87% in the week ended August 17th. That is the most since February 2009. Heating oil prices are down -7% in 2010.

Net longs held by fund managers in futures and options combined fell by 27,427 contracts to only 3,940 and the lowest level since February. Net long positions have declined -86% this year.

Fund managers are not just running from long positions in refined products but they are in panic mode to slash positions so drastically. This kind of sentiment suggests fund managers are significantly afraid the economy is going into double dip mode.

Jim Brown

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