Oil may be running out of new buyers

Defeat is not the worst of failures. Not to have tried is the true failure.

George Edward Woodberry

Over the last several sessions the market has tried to push oil prices into a downside corrective pattern, but so far each attempt has resulted in shallow and short lived moves lower. However, trading volume has been well below normal…especially in up days…suggesting that the market may be running out of new buyers and/or the existing long base of buyers is mostly near the upper end of where they want to be based on the current and projected market dynamics. I know I have discussed this many times but at the moment there is no shortage of oil anyplace in the world, thus much of what is driving the market is based on a twofold perception trade.

First the evolving situation in Libya along with the potential contagion of the democracy movement spreading to the rest of North Africa and the greater Middle East is perceived to result in a much larger supply interruption that may last for an extended period of time…obviously a bullish scenario for oil prices. The second perception is global oil demand is growing faster than new supply is emerging and thus surplus capacity of crude oil is declining. Although surplus capacity is still above the lows hit back in 2007 through the middle of 2008, it is now in a declining pattern that the main holder of surplus crude oil capacity – Saudi Arabia – has begun to increase its production to offset the million barrels per day plus loss of exports from Libya. The pattern of demand outstripping supply is a longer term trend and one that is likely to continue as long as the global economic recovery does not become derailed anytime soon.

It is difficult to try to put a probability on each of the main perception drivers at the moment as in some respects the supply driver or first driver can not only result in further price surges, but if prices did increase strongly from current levels that alone could work to derail the global economic recovery and thus the second main upward price driver previously described. Without putting a probability on it, I will say I view the perception of a major supply problem beyond Libya as not as likely as the media and the current price may lead one to believe. I actually believe that the Libyan situation is likely to result in some sort of cease fire and even a possible regime change during the next several weeks. If my view is correct, that would result in the risk or fear premium for oil receding modestly (but not completely) and lay the groundwork for the demand growth outstripping supply model to remain in place and provide a slow but sustainable increase in the price of oil over the medium- to longer-term.

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