They Are So Tired.
They’re so tired, they haven’t slept a wink. They’re so to tired, their mind is on the blink. They wonder if they should get up and fix themselves a drink but what they really are wondering where all the bullish momentum has gone. I mean come on it seemed like the oil bulls were on top of the world as the year started on such a bullish note. The bulls had their arguments like cold weather and China but with every passing day those arguments become more tired.
On the other hand the bearish case is wide awake. We have weak demand, ample inventories, rising OPEC and non-OPEC production and questions about the continued growth in China oil demand. Now throw in some proposed new banking regulations that could zap demand and it's the bull’s worst nightmare. No wonder they can’t get any sleep. The bull market and the bulls are just downright tired.
The Energy Information Agency weekly report did not help out the bullish case. The EIA did report that oil supplies fell modestly (400,000 barrels) and that we had a big drop in distillates (3.3 million barrels) but are we not to expect that when the weather is cold? And we are still above the average range in both categories. At the same time we had a huge build in gasoline supply 3.3 million barrels and a historical low refining run rate of 78.4 % which just seems too scream out weak non-weather related demand.
Of course the oil bulls would tell you that it is not about U.S. oil demand but demand from China. Yet is it possible that the oil demand story is not all it seems or at the very least the oil market got far ahead of the China demand story. I have been raising this issue for some time. Yesterday I warned that despite the fact of an explosive Chinese growth rate of 10.7%, the impact of China raising reserve rates and desperately reigning in credit could cause problems for the oil bulls. I warned that even though it raised market fears, the Chinese government will take even more steps to rein in credit. I said that the market’s reaction to the banking news could really be saying something more profound about how the market feels about the Chinese economy and even more, the health of the Chinese banking system as a whole.
Today the Wall Street Journal’s Liam Denning raised those same issues as well as others that I have talked about. Liam points out that, "last year, the Nymex crude oil price surged 78% despite global oil consumption falling for the second year in a row. China's continuing thirst for oil helped enormously as developed markets fell into recession. Ex-China, global consumption fell by almost 3 million barrels per day between 2007 and 2009. With China, it fell just 1.6 million barrels per day, according to the International Energy Agency."
But says Denning, "As is often the case, however, there's more to China's numbers than meets the eye." He says that the country's actual demand for oil, calculated as output from refineries plus net imports of refined products, jumped by 14% in 2009 quoting estimates from GaveKal Research. Gross domestic product growth for all of 2009 was 8.7%. Based on multi-year moving averages, China's ratio of oil demand growth to GDP growth should have been between 0.37 and 0.75 in 2009. That implies oil demand growth of just 3.2% to 6.5% last year. These numbers lend weight to a widely-held view that China has been stockpiling oil. Denning says that, "Another hint: Recent large exports of certain refined products from China suggest storage constraints."
More important will be growing financial constraints. Beijing has kicked off 2010 by imposing restraints on a domestic lending boom that has fuelled huge gains in speculative assets like real estate. Lombard Street Research says annualized growth in Chinese broad money and bank loans has been running at just under 20%, despite economic growth having largely recovered. That's a recipe for inflation and asset bubbles. Liam says that, "Less lending means less money to finance further oil stockpiling, weighing on prices." The more extreme risk would be for actual liquidation of existing stocks to kick in, which would savage cash prices. Chinese monetary tightening could limit gains for investors in passive vehicles tracking oil indexes.
A headwind already exists because of a sustained switch in the futures market to an upward sloping curve, known as "contango." Funds invested in oil futures typically roll their positions by selling near-term contracts close to expiry and buying the next delivery month. When the latter are more expensive, the negative return on that roll erodes gains made from increases in the spot price of oil. For example, in 2009, the Standard & Poor's GSCI Petroleum index made a notional spot price gain of 71%. But the total return, after accounting for the negative roll effect, was 19%. High oil inventories and weak end demand mean the contango structure will likely persist. Can passive investors really expect big gains in spot prices this year if China keeps tightening?
I say that the answer is no. That is why as I have been saying that oil is near a major top and is most likely headed back down towards $40 a barrel.
Phil Flynn is senior energy analyst for PFGBest Research and a Fox Business Network contributor. He can be reached at (800) 935-6487 or at firstname.lastname@example.org.