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Oil is the Next Major Commodity to Crash

EconMatters's picture




 

By EconMatters

 

We have seen how Gold and Silver were viciously attacked by the shorts this past week, and surprisingly Oil escaped the carnage which is interesting because in April Oil was taken down to the $86 level during the last attack on the Gold and Silver markets.  This is even stranger considering the fundamentals for the Oil market are even more bearish than they were in April from a supply standpoint as exemplified by the latest EIA report on Wednesday on this week. There is little doubt however that since the easy money is gleaned from the Gold attack, the Feral Hogs will start looking for their next target, and the Oil market will be high on their list in the upcoming months as the summer driving season winds down, and bulging supplies start to weigh on trader`s sentiments. 

 

This week`s EIA report identifies the problem with the Oil market as we had refineries running at the highest utilization rate of the year at 90% and yet there still wasn`t a draw in crude supplies. There have only been like 4 or 5 draws the entire year in Crude supplies. With Oil inventories above 390 million during the strong part of the year for oil demand, what happens to supplies when the slower part of the demand cycle kicks in for petroleum products?

 

Gasoline supplies are well above where they were last year at this time, and distillates are slightly ahead of last year`s inventory levels for this time of year. And for all that talk about added pipelines out of Cushing alleviated the oil glut....you guessed it, Cushing supplies are higher now than during this same time a year ago. This is hilarious considering the spread between Brent and WTI last year, compared to the $5 spread today. But that is the thing you have to understand about the Oil market: It is one of the most manipulated markets in the world. There is just so much money to be made in the Oil business and markets that the incentives for manipulation with lax oversight are just too inviting for the large players in the industry.

 

Take your pick either the spread should never have been $25 to begin with, or it shouldn`t be $5 today because nothing has changed at Cushing, Oklahoma.  In fact. there is even more oil stuck in the Midwest so to speak which was used as the rationale for having the spread in the first place, and rhetoric for why the spread was going to go away! More lies and propaganda used to push positions for profit! The entire spread is a complete farce.  Well, it was either a farce then or it is now because having both conditions given the actual data is illogical.

The headwinds for the oil market are as follows: The entire BRIC and emerging markets commodity inspired theme has come to an end from Brazil to India to China. In fact, some emerging markets seem destined for a crash. And the biggest Oil consumer of the BRIC play-- China-- may be growing at less than 6% in real terms. You don`t have to look at China to realize how bad it is in China for growth of commodities just look at the other commodity producer countries of Australia and Brazil to see just how much China has slowed in its consumption of raw materials, i.e., the fall in Iron-ore prices.

 

Moreover, the PMI`s coming out of China are going in the wrong direction, they aren`t getting better, they are starting to accelerate to the downside, and that was before the credit crunch of late. In addition, it appears too much past stimulus is part of the problem in China with regards to solvency issues and the shadow banking crisis that additional stimulus from the Central Planning Authorities is unlikely anytime soon. 

 

The next headwind is a strong dollar and despite Fed officials trying to talk down the dollar and bond market yields in the rest of the world is in far worse shape than the United States. Emerging market and Commodity currencies are imploding against the dollar.  With the advent of the weakening Yen strategy of Japan, the dollar seems destined for much higher levels. A higher dollar means commodities which are based and traded in dollars becomes more expensive, and is a bearish driver for prices.

Consumption is down in the biggest user of petroleum products the United States, while the emerging economies like China and India are really struggling economically, which is needed to offset the decline in US consumption. This is the real reason the Brent – WTI spread has come down with China not building a new city every month like they were in the developing phase.  India is in the midst of a recession, and Europe automobile sales is at record lows.  Nobody is going to pay higher prices for oil at the global level – and Brent is considered the Oil Benchmark for international demand. Brent under $105 tells you demand sucks internationally because if the players had their way Brent would be closer to $130.

 

Oil output and production is up globally, with US leading gains in the domestic US market not seen in decades. But here is the kicker for why Oil is in for larger inventory builds for the fall. The Saudi`s raise and lower production seasonally, i.e., they ship more to the US during the Driving season, and less in the Fall. But the US production is constantly rising because these are projects that are just trying to maximize production from an efficiency standpoint. So this new capacity comes to market regardless of the current supply levels or current seasonal demand patterns. You see this in the fact that we should be experiencing draws right now in Crude supplies as refinery utilization rates increase to produce more products for the seasonal driving demand. But yet we are flat or have had slight builds in Crude supplies because US production is making up the difference for season demand. The equation for the fall is the Saudi`s slow production as refinery utilization rates come down, but the US production still continues at or above the same rate and Oil supplies build with total supplies crossing the 400 million threshold. 

 

Even the Middle East is looking less threatening for potential supply disruptions with Iran electing a much more moderate leader this time around.  An Iran attack that was thought to be a possibility is looking less likely by most of the scholars on the subject from the political think tanks analyzing the latest dynamics. It looks like there will be a deal to scale back the size of the nuclear program in Iran which appeases Israel and the United States, and lifts the sanctions in Iran who need the economic boost as practical concerns have taken precedent over ideological drivers in the country`s politics. 

 

In short, almost every argument used in the past to support higher oil prices is actually heading in the other direction.  We haven`t even touched on the fact that there seems to be a problem of deflation, and not inflation, when it comes to commodities in general. All other commodities have deflated far more than Oil has, and especially if we take WTI which is up for the year.  This seems like the outlier that stands out, and will be correcting in the future. The price of WTI doesn`t match the fundamentals of the rest of the commodity complex, or even the fundamentals of its own supply and production levels.

 

The real question is when will the Feral Hogs fix their sights on the WTI market, and take it down to $80 like they have the last two years. My guess now that they have had their fun with the Gold and Silver markets, they will start looking around for their next target. The WTI price just stands out among the other commodities like a sore thumb. If they can take Gold down below $1200 on a couple of arguments, it seems there are at least five major arguments for taking WTI down to $80 in their next shark attack. Just watch out for all the I-banks coming out with their “research reports” after they are properly positioned for their takedown like we saw in Gold. 

 

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Fri, 06/28/2013 - 10:34 | 3703246 moneybots
moneybots's picture

"it seems there are at least five major
arguments for taking WTI down to $80 in their next shark attack. Just watch out
for all the I-banks coming out with their “research reports” after they are
properly positioned for their takedown like we saw in Gold."

 

If there are 5 arguments why oil should be lower, if those 5 arguments are correct, that will be the reason that WTI will drop to 80, not because shorts got positioned.

Sharks take advantage of a situation.

Fri, 06/28/2013 - 10:26 | 3703214 Orwell was right
Orwell was right's picture

I tend to agree with LawsofPhysics and CashisOptimistic.    

While this article does point out some interesting points to ponder, the harsh reality remains that the world is hooked on oil.   There is no viable....('viable' in this context means without SEVERE consequences)....escape.   In most modern societies,  people can only drop energy consumption so far....(and many are nearing that point now).....at which point they simply stop buying other "stuff" to pay for their energy bills/gasoline.     Going beyond that point will cause real pain and a significant reworking of their everyday life.        World wars have been started for less.     Oil may/will drop intermittently, but overall the cost of energy will either remain relatively high....or we will have a massive implosion and huge civil disorder....(otherwise known as war).    As for oil Supply....CashisOptimistic pretty much said what I was going to write.

Fri, 06/28/2013 - 10:36 | 3703250 CrashisOptimistic
CrashisOptimistic's picture

It's crash, not cash.  A Crash is optimistic.  The future is far darker than a mere crash.

As for world wars starting for less, thumb back through your history texts for the summer of 1941.  The US was the Saudi Arabia of the mid 20th century.  The US was the exporter of oil.

To Japan.

FDR cut them off with an oil embargo to try to stop the war in China.

Japan, like all sovereign nations, could not let national policy be dictated by a foreign power constraining oil supply (just as the US refused to abandon Israel during the Arab Oil Embargo, no nation can allow this) and so 4 months later the Japanese bombed the US fleet at Pearl Harbor -- to prevent that fleet from interdicting the oil supply they intended to get from Indonesia.

World wars have been started for less?  World wars have been started for EXACTLY THAT.

Fri, 06/28/2013 - 12:59 | 3703688 Flakmeister
Flakmeister's picture

Cash is prettty optimistic too.... :-;

Fri, 06/28/2013 - 10:26 | 3703198 ChanceIs
ChanceIs's picture

Several thoughts:

1) I saw a chart last week which showed flat or declining US gasoline sales over the last 4-5 years.  But the price is more or less flat - in spite of growth the the BRICs.  The author was pushing the point that if the US was having a real recovery, then gasoline consumption would be rising.  I agree with that.  I would also add that the low hanging fruit in terms of efficiency gains (cash for clunkers?) and less driving due to unemployment, etc have been wrung out.  Stated differently I see a floor under gasoline consumption/price right here.  Of course I couldn't imagine crude going to $35 with the '08 implosion.  BTW:  That implosion was forgotten about in Wall Street about three years ago.  It couldn't happen again (/sarc).

2) During the great crude excursion in the '05-'08 timeframe the average price was orth of $60.  That was an historically very high price and over an extended period. BUT LITTLE TO NO ADDITIONAL CRUDE CAME TO MARKET!!!!  The world should have been awash.  While Wall Street might have forgotten about the crude crash the oil and gas developers haven't.   I don't see them as having invested aggressively in new production.  I need to look at whether the majors are sitting on cash the way say...APPL...is sitting on cash.  Most big companies are sitting on cash.

So demand at bottom and supply at a top makes for a crash in crude prices!??!?!?!  I don't see it.

Now I am very much bought into the notion of paper market manipulation.  People were leveraged out the whazoo in '08 and crude got crushed.  Paper gold is clearly severed from the physical market.  Crude went to $10 in '98 and was way way distant from reality.  It snapped up to $30 in 18 months and Al Gore dumped the SPR in an attempt to buy the election.

Could crude be naked shorted back down to $35????  Of course it could.  And the author could be correct about the TBTF parasites looking for their host from which to suck the lifeblood.

Fri, 06/28/2013 - 10:42 | 3703272 CrashisOptimistic
CrashisOptimistic's picture

 

Think about costs of oil production in joules, not dollars.  That normalizes measures and extracts monetary this and that.

Now recognize that after about 4 years of drilling, there are more oil wells in western North Dakoka than there are in all of Saudi Arabia, who have been drilling 60 years.  That's not called fracking.  That's called frantic.  They are drilling 135 wells PER MONTH in North Dakota.

Why?  Because shale wells decline their output so sharply after day 1.  They lose 35-40% of output rate in one year.  Contrast that with Saudi Arabia wells, some of which are down 1% every 20 years.

Now visualize the "cost" (in joules) to get joules out of the Bakken.

Now you start to understand how the end is coming.

Fri, 06/28/2013 - 11:20 | 3703353 Bearwagon
Bearwagon's picture

Here's some of the theory of EROI, notably the EROI-price correlation:

http://www.theoildrum.com/node/9249

Fri, 06/28/2013 - 12:58 | 3703687 Flakmeister
Flakmeister's picture

CoI bringing up EROEI is appropriate but as long as there is a significant price premium for liquid BTUs, BTU arbitrage will occur. The arbitrage will continue until you cannot make any money from it, simple ECON 101. Whether it is collectively suicidal, well, when has that ever stop segments of society doing what they saw best fit to do?

The Bakken wells are still profitable on a cash and EROEI basis. And even if the price drops such that a well becomes un-profitable, it will not be shut in. After the well is drilled, it is about the cash flow. Of course, if the company has zero retained earnings it is real tough to drill the next welll....

Fri, 06/28/2013 - 11:52 | 3703336 ChanceIs
ChanceIs's picture

In some ways you are addressing the EROI (sometimes EROEI) concept - Energy Returned on Energy Invested.  That has been dropping for some time, and when it hits "1" the the s^&t is just contacting the fan blades.  You are on good ground raising that issue and I rather sure that your facts about the well count per barrel is correct.  The decline rates have been high for some time.  However that is icing on the cake of my arguments.  The cash cost of the additional wells is not falling to be sure.

Another factor to consider is the "social cost" of crude in the Middle East.  The price of food there has gone up.  (Thank you for exporting that inflation Mr. Bernanke.  Egyptian President Morsi and the Islamic Brotherhood thank you as well.)  Suadi has made that up by increasing the price of its crude exports and either paying "welfare" directly to its citizens or subsidizning the cost of food in the markets.  The entire "pucker factor" of the ruling classes in the oil exporters went up with Arab Spring.  The social supplements will not go back down.

There is yet another factor, the "export land model," related to oil exporter's internal consumption.  They like to drive cars and have the good life.  Mexico in particular is predicted to become a net importer in the next 5 (?) years.  Its simple.  Their production is dropping while consumption is rising.

Graph of EROEI.  This should help everyone sleep at night.

http://8020vision.com/wp-content/uploads/2011/10/eroi_eroei_discovery.png

Graphic of Mexican Export Land Model:

http://upload.wikimedia.org/wikipedia/commons/6/6a/ELM_Mexico.png

Fri, 06/28/2013 - 13:15 | 3703739 CrashisOptimistic
CrashisOptimistic's picture

We unfortunately tend to preach to the choir in comments because we never know who has already read what.  Certainly the articles are useless once we get started because the writers pretty clearly know so little.

But a point here that is not widely covered . . .

"The cash cost of the additional wells is not falling to be sure."

The Oil Drum has gone badly downhill since the oil focused commenters left the site and global warming guys and solar cell guys now dominate discussion.  Not really The **Oil** Drum anymore, but regardless of that, your quote . . .

The issue is efficiency increase -- they are doing four horizontals into 4 directions now from one vertical well versus the sweet spot problem.  They have already hit the richest holes.  So efficiency is up, no question, has to be -- but they are squeezing an already squeezed sponge.  Even if you go in new directions horizontal, the first 10s or 100s of feet of that travel has been squeezed by the previous well.  So horizontal well #1 gets you X bpd.  #2 does okay 180 degrees away from #1, but 3 and 4 are squeezing rock already squeezed.

Then the next hole drilled is less sweet even for #1.  In other words, no question efficiency has to rise by virtue of experience.  But there are obstacles efficiency can't address, namely, there's nothing there anymore.  The cost gain from initial efficiency gain is eroding.

And now the financing costs of drilling just went up with the 10 yr.

Fri, 06/28/2013 - 10:14 | 3703173 disabledvet
disabledvet's picture

the Feral Hogs have their sights set on Texas. hmmm. the Federal Government could allow for oil exports which is price supportive. of course deployment of an all electric vehicle infrastructure is VERY negative. plus you have natural gas which is rolling over and 75 percent cheaper as well. did I mention ethanol? the collapse of Venezuela? the collapse of Brazil and Argentina? "Chinese demand" was always a big pile of hooey. US demand is the only game in town right now...and it...is...lacking.

Fri, 06/28/2013 - 10:13 | 3703170 CrashisOptimistic
CrashisOptimistic's picture

The article writer does not understand oil.  He is saying Old Normal words about things that no longer exist.

Oil's price is now determined by refineries, not NYMEX. 

The condensate coming out of the Eagleford shale (and the Bakken) does not power trucks.  All "oil" doesn't contain 5.6 million BTUs/barrel and this writer doesn't understand that.

When consumption is in decline and price doesn't fall, Occam's Razor suggests you not go looking for convoluted conspiracies to change the price. 

Rather, the simplest answer is to challenge the abundance story.

The Old Normal thinking about what Saudi Arabia does is similarly dated.  Have a look at Saudi Arabia internal oil consumption compared to 10 years ago (where you learned what you thought you learned).  KSA has exploded their oil consumption, because in the summer they run air conditioners and their electricity comes from oil.

Fri, 06/28/2013 - 10:41 | 3703270 Bearwagon
Bearwagon's picture

Not all oil does contain 5.6 million BTU/barrel, that's right. Just in case someone would like an example of an oil-like liquid that doesn't: "Dilbit"

https://en.wikipedia.org/wiki/Dilbit

Fri, 06/28/2013 - 11:48 | 3703306 Flakmeister
Flakmeister's picture

Its a good question, but you really have to dig into the assay info

http://www.crudemonitor.ca/assay.php?acr=WCS&crudename=Western%20Canadian%20Select

and compare to get your answer... Sorry, I can't find my standard reference link that would have the answer..

My wager is that the BTU/bbl is very similar but the effective yields are lower because of the additional energy needed to crack the higher carbon fraction chains in the bitumen (the bitumen is higher energy density).

http://astro.berkeley.edu/~wright/fuel_energy.html

Edit: In fact, one can calculate the BTU/bbl from the above data by weighting the componets of dilbit.. Fill you your boots and get back to us

Fri, 06/28/2013 - 10:53 | 3703295 CrashisOptimistic
CrashisOptimistic's picture

Excellent link.  Recommended reading.

Fri, 06/28/2013 - 10:33 | 3703244 Flakmeister
Flakmeister's picture

CiO,  while you are bang on noting that a fair chunk of the EFS is condensate with API > 45, i.e. deficient in long chain hydrocarbons that you find in distlliate, I would not push that argument too for the Bakken. Bakken produduction for the most part is real crude oil. However in other plays like the Utica and the Marcellus, the associated NGLs coming out are unfairly counted as crude...

Fri, 06/28/2013 - 10:50 | 3703285 CrashisOptimistic
CrashisOptimistic's picture

Flakguy, I parenthesized the Bakken inclusion, pretty much for your reasons.

There is rather a lot of talk of blending with Canadian oil to raise the API and make it amenable to more broad refining and there have been suggestions of a joules reduction from this.

It somewhat makes sense at a molecular level.  If there are shorter CH chains, the stuff weighs less, and the joules do come from breaking the chains.  If there is less length, there are fewer joules?

But largely, Shrug.  I wish we had solid data on this.

Fri, 06/28/2013 - 10:58 | 3703312 Flakmeister
Flakmeister's picture

Ask and ye shall recieve, see my link below from Berkeley....

Fri, 06/28/2013 - 10:17 | 3703181 disabledvet
disabledvet's picture

we get our oil from Canada and Venezuela you moron. we're about to be independent of them as well. this is a GLUT.

Fri, 06/28/2013 - 10:26 | 3703216 Flakmeister
Flakmeister's picture

Quit making shit up....

The "glut" is a pimple on the ass of the global oil market (~3% of total global stocks) is due to the landlocked nature of the new supplies in the mid-continent...

You are aware that the EIA classifies 10% of domesitic production as refinery volumetric gains from *imported crude oil*... Almost makes my head spin...

Fri, 06/28/2013 - 10:13 | 3703169 moneybots
moneybots's picture

"We have seen how Gold and Silver were viciously attacked by the shorts this past week"

Short covering has always made prices go up. Shorts viciously attack the whole time a market goes up, anticipating wrongly that they are shorting near the top.

 

Fri, 06/28/2013 - 10:05 | 3703145 Flakmeister
Flakmeister's picture

Unlike gold which is not physically consumed, you cannot drive the price of oil down below the cost of marginal cost of a new barrel for any length of time...

The only way this scenario comes to pass is if demand drops faster than the natural decline of existing fields, ~5%...

Fri, 06/28/2013 - 10:18 | 3703185 disabledvet
disabledvet's picture

oil has already been replaced.

Fri, 06/28/2013 - 10:26 | 3703217 Flakmeister
Flakmeister's picture

Troll...

Fri, 06/28/2013 - 09:47 | 3703096 LawsofPhysics
LawsofPhysics's picture

Total bullshit.  Unfortunately, unlike PMs, oil remains the single most fungible source of energy and commodity chemicals on the planet.  Also, unlike PMs, everyone on the planet buys oil or the products of oil every fucking day.  Go ahead, drop the price, there is 7+ billion people on the planet (and growing), demand is going nowhere.  When the ability to actually deliver cannot be met, that is when WWIII starts...  like I said, go ahead, drop the price of oil, I dare you, will be fucking great for the average sheep and anyone who actually produces anything real fucking value.

Fri, 06/28/2013 - 10:21 | 3703197 disabledvet
disabledvet's picture

again "US oil cannot be exported." natural gas export terminals are a LONG way off too. this price will FALL.

Fri, 06/28/2013 - 11:10 | 3703328 LawsofPhysics
LawsofPhysics's picture

Bullshit, international oil companies can and will move oil to whereever it is most profitable.  They do already.

Fri, 06/28/2013 - 09:55 | 3703118 Bearwagon
Bearwagon's picture

Drop the price? That would be nice, but I doubt it will ever happen. I think more about prices rising substantially. Would be great to buy heating oil on the cheap, but that alone is an indication (at least to me) that it won't happen. And just to add some humour for those who appreciate it: Oil, like PMs, isn't backed by anything. Harharhar! +1

Fri, 06/28/2013 - 10:12 | 3703163 marathonman
marathonman's picture

Giving yourself a +1 for your own post?  I like your moxy.

Fri, 06/28/2013 - 10:19 | 3703186 Bearwagon
Bearwagon's picture

Well, if you have to ask about it, you shall get an answer: The "+1" means that I gave LoP an upvote, not myself (because I never vote myself up and neither down). I hope that clarifies it. (P.S.: You try german, than we talk again;))

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