[+ Font] :: [- Font] :: Printable

The Energy Report

Phil Flynn
November 16, 2007

So much for immortality. Saying goodbye to the December crude oil futures contract is going to be met with mixed emotions by many traders. Oh sure, the contract achieved the status of trading at an all time high but never achieved what many believed was its $100 destiny.

As the contract goes off into delivery and into the history books, there is a feeling by many (especially those holding $100 call options) that somehow the contract didn’t achieve it destined immortality. There is the thinking that somehow the December contract was great but not as great as it could have been. It fell short of 100 glory.

Why did oil not hit $100 a barrel and why is $100 a barrel so important anyway? And what does our obsession with the price level of $100 a barrel say about us and the economy and the marker in general? Well it says a lot of things but first let’s talk about why we sold off yesterday.

Yesterday the quest for $100 a barrel for the December contract was basically demolished as the weekly inventory report from the Department of Energy was bearish as I expected. As I said yesterday in my daily report, the last best hope for $100 a barrel in 2007 may come in the form of the delayed weekly inventory report which by my best estimate could be a bearish surprise as a surge of imports and returning Mexican production might find their way into this week numbers.

And that was exactly what happened. Imports surged and refineries jumped back on line and the Department of Energy reported that crude oil inventories rose by 2.8 million barrels to 314.7 million barrels. That broke a string of four straight draws in supply that had some analysts assuming that the slide would continue. Imports rose by 831,000 barrels a day to there highest level since the week of August 17.

Gasoline supplies also fell in response to a noticeable drop in demand.

The distillate though is still a concern and helped the complex rally out of a deep hole but was not bullish enough to carry the entire complex on its back especially with signs all around that demand is reacting to the sharp spike in price.

Because prices spiked so hard and so fast towards $100 a barrel the market was bound to correct. The users of oil have cut back on its use responding to the sharp rise in price. The IEA (International Energy Agency) and OPEC both cut their estimate of world oil demand for this year and next. Both are saying that there are signs that oil prices close to 100 a barrel are depressing demand. Of course remember the further we fall away from $100 the opposite will be true.

I have said this before but the real reason demand is falling is price shock. Not price shock in the traditional oil economic calamity sense but shock from buyers that prices have gone up so fast. When prices rise sharply and quickly it takes some time for the buyers and sellers to catch their collective breath.

China has cut demand because it has been shocked at how fast prices have gone up. Companies that use oil have also taken a step back. Now if prices edged up a couple of pennies a week over an extended period of time then we might not notice but when we rise so fast it is a momentary shock. It's not that we won’t go back to our old habits but we want to see prices ease back down a bit and collect our thoughts and when they do we will start slowly increasing our consumption again and the next time we hit these high price levels somehow it won’t seem so bad.

I am not saying that oil won’t hit $100 a barrel, but I am saying that unless we get some type of major event it won’t happen this year. The market seems to be adjusting to the higher price and the recent surge was high enough to assure that supplies will be adequate for winter. Many critics blame the speculators for the big move in oil yet what really was happening was the market was going high enough to slow demand enough so that we would have enough supply. This is a classic example of how free markets are supposed to work and why despite record high prices the economies of the world flourish and we don’t see gas lines and shortages.

Even the Department of Energy says that the fundamentals justify the price.

Oil has been driven by fears and facts of tight supply. And it had to be driven higher and higher until we hit a price where demand finally dropped. And fell in a significant enough fashion to basically assure us they we would have adequate supply. The drop in demand is not a sign that the economy is necessarily weak but was moving too strong too fast. The price of oil had to put the breaks on US drivers and ravenous demand from China until the supply of oil could start to catch up. Already now we are seeing inventories of oil stop the downslide and that is a good thing. The critics will say supply was never tight and the increase in supply is proof. But I contend that supply would have a harder time rising if demand were was not curtailed.

So the debate will go on between the bulls and the bears and ultimately the truth will be expressed in the price. Isn’t this free market thing cool? Just beautiful! Life, liberty and free markets that helps us in our pursuit of happiness!

Call for day trades and the latest option updates! I am Phil Flynn and you can reach me at 800-935-6487 or email me at pflynn@alaron.com.

Buy January crude oil at 8900 - stop 8700.

We're long December heating oil from apprx 25500 - stop 24500. If not stopped roll to January moc.

We're long January RBOB from apprx 23200 - leave stop at 23000.

We're long January natural gas from apprx 808 - stop 797.

Have a GREAT day!