Sunday, February 15, 2015

Commodities: The Logical Flaws Of The Oil Rally

(Drivebycuriosity) - Oil got expensive again. The price of oil (Brent Crude) jumped around 30% in the recent 4 weeks! The aggressive oil price hike is astounding because the already record high US oil inventories & production are still rising (

The oil rally has been driven by massive speculation (oilprice reuters cnbc). Hedge funds and other speculators are betting that

- US shale oil production, which caused the global oil glut, will drop significantly in the coming months
- OPEC will cut production on their next meeting in June
- global oil demand will rise soon thanks to a stronger global economy

Apparently many gamblers are betting that all three alleged factors work together which could lead to a sharp (v-sized) oil price recovery like in the years 2009 and 2010.

                                                 Moving Targets

I disagree. I think that the oil rally has logical flaws:

1. US oil production & inventories rose in January in spite of the overhyped shutdown of the oil rigs ( Many of the oil rigs are profitable at prices around $60 and the switched off rigs will come back if prices rise further (marketwatch  bloomberg). The costs of extracting oil from shale are falling - thanks to new technologies and advanced engineering ("The break-even price point is a moving target" marketwatch ). US producers are even re-activating abandoned old oil wells (re-fracking bloomberg Technology). Rising efficiency & productivity gains might explain why the US oil production is still climbing.

2.  An OPEC production cut in June will be less and less likely if the oil rally continues. Saudi Arabia declared that they accept very low oil prices in order to squeeze out the US shale competitors. A rising oil price would foil this strategy.

Other oil producers - like Iran, Russia, China & Iraq - might not agree to a production cuts because they want to produce more oil to finance their budgets ( and to benefit from a political stabilization (Iraq).

OPEC - and other oil producers - have also to bear in mind that the cost for alternative energies - solar power & wind craft - are falling. Apple already invested $850 in a solar farm to power a part of their stores, offices, headquarters and data centers (bloomberg). And electric cars are getting more popular. Maybe in some decades the demand for oil will be much lower than today. It would make sense for Saudi Arabia and other oil producers with low costs and huge reserves to sell oil  as long they get a (relatively) good price for it.

3. Global oil demand will recover less than the speculators expect, because oil is still expensive. Brent crude cost around 3-times what we had to pay before 2002. This is still enough incentive to save money and to reduce oil consumption (demand destruction). History shows that rising oil prices are slowing down the global economy.  Climbing oil prices in the years 2009 and 2010 are one of the causes of the disappointingly slow recovery of the global economy.

Resume: I believe that the recent rally is just a "dead-cat-bounce", driven by a snowball effect (price gains attracted more gamblers who´s purchases add to the price hike). I think that the fundamentals,  meaning strong supply & weak demand, will continue and the oil glut that will flush away this rally.

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