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4 Mar 24 2011 @ 9:27am by Matt Smith in Crude Oil, Economy, Global Energy, risk management

10 Reasons Why Crude Should Be Falling This Week…But Isn’t

Grrrrr*. The contrarian in me has been somewhat bated, as although I believe crude prices should be moving higher based on all the uncertainty in the Middle East and Japan, we have seen a number of bearish indicators in markets generally this week which – if released at any other time – would usher the crude market lower. So in order for us not to get too wrapped up in pointing in one direction (…to infinity and beyond), here’s ten reasons why crude should be falling this week…but isn’t:

1) All is not well in the European economy (Part 1): Portugal – the 36th largest country in the world by GDP – is about to go bankrupt, and is set for an ‘inevitable bailout’.
2) The US housing market is in disarray. Existing home sales are sinking like a stone, while new home sales have fallen to a record low in February, while nearly 20% of Florida homes are vacant.
3) Although current events in Japan are likely to have a positive effect on oil demand in the longer run as the recovery process kicks in, a lack of immediate demand for crude due to 30% of oil refining being offline means demand destruction for the crude market.
4) All is not well in the European economy (Part 2):  UK  – inflation is 4.4% (anything over 2% means a slap on the wrist for the Bank of England and a letter of explanation to the Chancellor), while the economy is contracting. The Government has also just cut its economic growth forecast for 2011 all leading to the equation:  a stagnating economy + rising inflation = stagflation.    
5) Yes the Japanese equity market may be rebounding, egging on risk appetite and lending support to global equties, but………it is already well UNDERVALUED, due to Japan’s utterly poor economic performance in recent times: 

6) Economic data elsewhere has not been overly supportive for markets, with weaker than expected numbers from US durable goods, to European manufacturing and services, to UK retail sales.
7) All is not well in the European economy (Part 3): rumors of an Irish bond default circulate, although denied by some camps.  Despite bond yields indicating immediate problems, a bailout is unlikely until after stress test results. Meanwhile, their economy sinks 1.6% in Q4, 2010.
8) And another thing re Japan; not only is refining down, but actual productivity has dived. Output has been hit as much as 6%, crimping economic activity, both now and for the immediate future. And the impact is much more far-reaching than just on a domestic scale, as international auto and electronic markets are materially affected. 
9) Middle East unrest – the threat of Libyan oil production being offline for the majority of 2011 has now been priced into the market to a large extent, while Saudi production has increased to meet the shortfall. Upside risk to oil prices is driven by fear rather than fundamentals, should unrest in countries such as Yemen or Bahrain spill over into Saudi Arabia and impact oil production. 
10) Gasoline demand in the US may be strong (albeit seasonally), but we as we exit the high-demand period for heating oil, inventories are above levels seen at the same time for the last five years. Meanwhile, crude inventories are above both last year’s level and well above the 5-yr average, and total products supplied (a proxy for total product demand) are below last year’s level and near the low end of the 5-year range.  Not crazy bullish.

*the bear in me

4 Comments on this post:

  1. Shreg says:

    So Smudger, I get the reasons why it should be falling. So why isn’t it?

  2. Matt Smith says:

    The market is running on emotion, Shreg – fear over fundamentals. A market that doesn’t fall on bearish news is not bearish; the trend is your friend. (insert favorite cliché here).

  3. Shreg says:

    Fear can be a good thing sometimes. It adds focus until it gets to panic levels. Great post as usual.

  4. Jim Etzkorn says:

    Stagflation – I’m surprised that this word doesn’t pop up more frequently than it does…you’re spot on for putting it out there. I suspect that the term brings back to many painful memories of the mid 1970s…memories that have not insignificant chance of being relived in the not too distant future.
    Nikkei – Correct again. Likely true that the unfortunate events there have created a buying opportunity for the (very) long term, but there are way too many unknowns in the near and medium term to count on any steady improvement aside from immediate recovery demand. This bouncing cat is likely dead.

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