Dollars and Demand

Jim Brown
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It was another rocky day for crude on Monday after several news items suggesting demand was slowing and the plunging euro pushed the dollar to a two month high. Rest assured any decline in oil prices is temporary and represents a buying opportunity for energy stocks.

WTI crude declined -$2.40 to close at $97.70 on Monday and Brent declined a similar amount to settle at $110.10. The U.S. dollar index rose nearly a full percent intraday and forced selling of commodities and equities as stop losses were hit.

Platts, the energy information of McGraw Hill, reported crude demand slowed in China in April. On the surface that headline could produce a knee jerk reaction and prompt selling. In reality demand did "slow" but that means it increased at a slower pace. In April crude demand increased +8.3% in China to 9.37 million barrels per day. That was down from an average of 10% demand growth in the first quarter. We also have to take into account that calendar issues impacting delivery in April as well as severe storms increasing the use of oil for generating electricity in Q1.

Even though the increase in demand slowed slightly it still grew by nearly 125,000 bpd in April. When you look at it that way the minor slowing in the amount of increase is less important. We also need to remember China is trying to slow its economy so we should expect demand to increase more slowly.

The bottom line is China's demand will be over 10 million barrels per day by year-end. Obviously new production around the world is not growing that fast.

Another demand concern came from the USA where the Chicago Fed National Activity Index fell back into negative territory in April. The headline number came in at -0.45 compared to a +0.32 in March. The three month moving average turned negative for the first time since December. This was the weakest reading since August 2010 for the index. Three out of four major categories saw declines.

The CFNAI report is not really a widely watched indicator but coming on the heels of several other regional reports over the last several weeks that all pointed to slowing growth it was another confirmation point that traders did not want to see.

On Tuesday the more important Richmond Fed Manufacturing Survey will be released and it has declined for two consecutive months already from 25.0 in February to 10.0 in April. A continued decline will probably also be viewed as slowing U.S. demand.

All of these daily data points only serve to create volatility in the market. The amount of existing oil demand that has disappeared from the market is miniscule. It has most likely already been made up and surpassed from the increased demand from India, China and Latin America. These short term fluctuations due to economic reports are just noise.

Gasoline prices are dropping like a rock ahead of the summer driving season and any demand that was delayed by nearly $4 gasoline in the USA will be forgotten after Memorial Day.

Use these temporary declines in crude to enter positions for the longer term. The fundamentals of oil demand have not changed. Demand increases every year and should exceed 90 mbpd in 2012. OPEC, in their May update is still expecting demand to increase by 1.4 mbpd in 2011 and a like amount in 2012. If the economic recovery in the U.S. ever gains traction that could increase by another million barrels. Unfortunately production is NOT increasing by the same rate.

I hate to sound like a dripping faucet but long-term positions in oil based energy stocks is a winning investment strategy.

Jim Brown

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