China May Not Come To Our Rescue

Jim Brown
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Crude prices fell on speculation that China's central bank may move to slow bank lending to avoid over heating the economy. Tighter monetary policy could limit China's growing demand for crude. Elsewhere warmer weather and comments that there is plenty of oil in storage to meet winter demand caused crude prices to stumble for the first time in nearly two weeks.

Analysts who study fund flows confirmed that new year-end retirement money moving into energy funds had been strong over the last two weeks. Also, there is a commodity fund rebalancing on Friday that is raising the weighting on crude oil. It has been the perfect storm for crude with a variety of factors combining to push prices higher. Unfortunately we all know what happens when the storm is over. Calm prevails and positions are evaluated under the bleaching influence of bright sunlight.

An IMF Global Analyst, Edward Meir, reiterated their position statement on crude on Thursday with "We still fail to see any compelling fundamental reason why crude oil prices are where they are. The weather is cold, but it was also cold this time last year when prices were $33 a barrel." Good call Ed, couldn't have said it better myself. Ed followed up with the "money flowing into commodity funds" excuse in the next paragraph.

Demand for heating has risen by 21% in the U.S. and even more in other parts of the world. However, contrary to sound bites in the news, analysts claim there is sufficient crude oil, heating oil, coal and natural gas in place to handle any continued cold weather. The party poopers are at it again as they rain on the bulls parade. However, I don't think the bulls have been listening. It has been a momentum play all along and the shorts, expecting a post year-end decline simply got squeezed.

Illinois based Ritterbusch and Associates said "Above the $83 level we would be viewing this price advance as falling within the "bubble" category, a scenario that could play out in a much sharper than expected price plunge." Olivier Jacob at Petromatrix in Switzerland said "We do not believe in the sustainability of Nymex crude at the $85 level."

Another disclaimer over the "surge in usage of heating fuels" came from Olivier saying "U.S. distillate stockpiles were at the highest level since 1985 when 2010 started. This means the U.S. refining system does not even have to increase its output of distillates. The U.S. is a net exporter of distillates like heating oil and all refiners would have to do is direct some flows back into the country rather than continue exporting their surplus.

The Energy Department said crude inventories rose 1.3 million barrels last week, the first increase in five weeks. Stockpiles were forecast to fall by a Bloomberg News survey. Supplies of distillate fuels such as heating oil dropped less than expected. "There?s enough crude oil everywhere and no shortage of distillates, so even with the cold winter fundamentals are weak," said Gerrit Zambo, a trader with Bayerische Landesbank in Munich. "Between $60 and $70 would be a more fair value. It's only a matter of time before a correction."

Oil supplies at Cushing Oklahoma, where WTI futures are delivered, rose +1.16 million barrels to 35.7 million barrels last week. That is the highest level since tacking started in 2004.

Let's review:

Supplies of heating oil declined less than expected.
The forecast is for much warmer weather next week.
Refiners will not have to increase production because of excess inventory.
No recognized energy consultancy believes fundamentals support $82.
OPEC countries are in full cheat mode and with $82 production will only rise.
Crude prices are up due to year-end money flowing into commodity funds.

Sounds like a reason to be bearish. However as many ex shorts can tell you, the market can stay bullish despite bearish fundamentals and it can remain that way far longer than most traders can stay liquid.

I believe we are nearing a tipping point once the payroll report passes. Assuming it does not surprise strongly to the upside and give the bulls something else to cheer about I believe price action on Monday could be an entirely different picture.

Jim Brown