HardAssetsInvestor

June 27, 2012

Crude Oil Fundamentals Signal Bottom Forming After 30% Sell-Off

Details

Oil prices may begin to bottom out after selling off sharply on oversupply concerns.

The Department of Energy reported this morning that in the week ending June 22, U.S. crude oil inventories decreased by 0.1 million barrels, gasoline inventories increased by 2.1 million barrels, distillate inventories decreased by 2.3 million barrels and total petroleum inventories increased by 2.6 million barrels.

Crude oil prices have rebounded over the past few sessions, led by Brent, which is up from $88.50 to nearly $94. WTI has underperformed slightly; it’s up from $77.50 to $80.50.

Since peaking in February above $128, Brent has fallen precipitously (~31%). Throughout that decline, there have been intermittent recoveries, though all proved temporary. Is this bounce the one that will last?

BRENT

WTI

From a technical perspective, it is too early to tell. Prices have yet to show any signs of bottoming, though they may in the coming weeks.

That said, the fundamentals suggest the bottom may be in. In our view, demand-side risks have been amply priced into the market. While the eurozone remains an obvious concern, data in the U.S. and China have not deteriorated significantly. Growth is relatively slow, but recession fears are overblown barring a financial shock in Europe.

Additionally, geopolitical concerns are creeping back into the market. The recent tensions between Syria and Turkey may have broader implications for stability in the Middle East, even though neither country is a significant oil exporter.

With OPEC spare capacity at extremely low levels (2.38 mmbbl/d as of May), the oil market is vulnerable to supply shocks.

Moreover, the thin cushion gives the cartel—particularly Saudi Arabia—a substantial amount of control over the direction of prices. For much of the year, the Saudis have chosen to open the spigots to lower prices. After the recent correction, the country may switch gears to support prices.