Oil Positive Despite Dollar Gains

Jim Brown
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Crude oil rebounded from early losses to end slightly positive after the dollar surged to a new four week high.

The dollar has been crazy lately. Bernanke talked about tapering starting in September and it took off on expectations for the end of QE. As we know now those expectations are fading but the dollar is still in rally mode. The sharp downward revision in the Q1 GDP from expectations of +2.5% growth to actual growth of only +1.78%. Since future quarters will have significant drag from the sequestration of -1.5 or more GDP points that would put the Q2/Q3 GDP at barely over zero. That is not an environment that would be conducive to the end of QE4. The dollar has not gotten the news and continues higher every day.

Dollar Index Chart

Commodity prices collapsed again with the emphasis on precious metals. Gold lost -$46 and silver almost -$1. Gold is now $1230 and a level not seen since November 2010. The rise in the dollar and the economic decline in China is offsetting a huge surge in buying as investors around the world rush to take advantage of the dip.

Gold Chart

Despite the commodity dump today the price of crude remained relatively stable at $95. That is only $5 below the price for Brent as the spread continues to shrink. I believe they are going to meet later this year around $100 thanks to the increase in U.S. production and the continued security issues overseas.

Crude Oil Chart

The EIA inventory report today showed crude levels remained flat at 394.1 million barrels despite another small increase in refinery utilization. Refinery utilization rose to 90.2% and the first time over 90% this year. We should see it remain at that level or higher for the rest of the summer. Refined products rose to a multi-month high at 15.7 mbpd.

The increase in refinery production pushed gasoline inventories to 225.4 million barrels, a gain of +3.7 million and a multi-month high. Distillate inventories rose to 123.2 million barrels, a gain of +1.6 million.

Crude imports declined by -173,000 bpd but that was offset by an increase in U.S. production of +132,000 bpd.

Gasoline imports spiked +381,000 bpd to account for all of the rise in inventories. Production rose +33,000 bpd but demand increased by +54,000 bpd to offset the increase in production.

Distillate inventories rose due to an increase in production of +189,000 bpd along with a smaller drop in demand of -121,000 bpd. Distillate imports rose +5,000 to 92,000 bpd.

Inventories at Cushing rose slightly to 49.3 million barrels but the shipment of oil by rail from the shale oil fields is relieving the pressure on Cushing. That is also having an impact on WTI prices since producers are able to sell their oil for a higher price if they ship it directly to the refiner by rail.

Inventory Snapshot

Analysts continually moan about the lack of gasoline demand compared to early 2008 levels. What they don't take into account is the high level of unemployment. There are 2.5 million fewer people employed today than there were in 2007. That is 2.5 million people who are not driving to and from work every day. Until employment returns to normal the demand for driving fuels will continue to be weak. Demand is improving as we get farther away from the recession but the pace of increase is very low.

Another factor is the price of gasoline. When I was a kid we would buy $5 of gas or maybe splurge and get a fill up for $10. We lived in our cars but gasoline was 29 cents a gallon. Today with gasoline averaging $3.75 and the average teenage wage only $7.50 they have to work an hour to buy two gallons of gas. Taking a date out to eat ($20 for fast food) and then a show ($40 for two tickets and refreshments) and that turns into three days of work to pay for the date. That assumes the teenager has a job and today the unemployment rate for those aged 16-19 is 24.4%. That means 1 out of 4 teenagers are unemployed. Being unemployed today means you are not driving very far at $3.75 per gallon.

Will this ever change? It will change once the economy recovers to the steady rate of 3.5% to 4.0% GDP. That could happen by 2015 to 2016. However, several Fed presidents have recently predicted that unemployment would remain over 7% until 2015. The economy needs to create 150,000 new jobs every month just to accommodate new immigrants and graduates. We have only created an average of 155,000 new jobs over the last three months. That means the unemployment rate is stagnate and we are just breaking even with the increase in jobs.

Gasoline demand is not going to increase significantly until 2015. The Great Recession has postponed Peak Oil until late in this decade. Just a couple years ago analysts were predicting it to arrive in 2014 but the global economic dynamics changed with Europe in recession and the U.S. crawling along at a snail's pace. With China's slump accelerating it is hard to know when demand will begin pressing the limits of production again. New production is coming online every year to offset that we are losing from older fields so supply and demand appear to be roughly in balance for the next several years.

The next problem we are likely to face is prices versus production. We are getting more oil out of the ground thanks to the high price for oil. With production costs rising to $75 per barrel in some locations that should put a floor under crude prices. As we saw in the gas glut over the last several years when it costs more to produce it than you can sell it for the majors quit producing.

If oil were to decline under $75 some of the shale areas and some offshore areas would become uneconomical to produce. That will slow new production growth and bring the supply demand equation back into focus. The only factor in the entire oil equation that never changes is depletion. As oil is produced less oil remains and the volume of daily production declines. It is a basic law like gravity and improvements in recovery methods can only slow the decline not halt or reverse it.

There is nothing on the calendar this week that is likely to change oil prices materially. The hurricane map is quiet. In fact there are not even any clouds to speak of according to NOAA.

Hurricane Outlook Map


The markets are back in rally mode or at least the last two days have posted gains. The S&P rebounded slightly above resistance at 1600 and the Dow eased over 14,910 but that is far from new highs in each case. Each has reached a resistance point that could prove tough to conquer.

Supporting the equity market is the monster outflows in cash from the bond market. Trimtabs.com reported a record $61.7 billion in outflows from the bond funds and ETFs for the three weeks ended June 24th. This exceeds the prior record of $41.8 billion in October 2008. Some of that cash is now sloshing over into the equity market and that could power continued gains.

Historically the last week in June after the triple witch expiration is negative as a result of the Russell Index rebalance on June 28th and then the first week in July is typically bullish. After that the historical trends tend to fade until August when the dog days of summer see the indexes begin to decline after the Q2 earnings reports.

Dow Chart - Daily

S&P-500 Chart

The energy sector is declining as I expected and we should see further declines in the July-August period. Be patient and we will use any weakness this summer as a buying opportunity.

Jim Brown

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