Oil Markets in Grip of Speculative Mania

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"Players are simply ignoring increasingly negative fundamentals. . ."

Crude oil markets are in the grip of a speculative mania. Players are simply ignoring increasingly negative fundamentals, such as supply/demand balances. But before too long, this over-bullish sentiment will have to reconnect with fundamentals. At that point, users will be left to pick up the pieces, as the financial players panic and rush for the exits.

Current U.S. crude oil inventories are only 2.2MB below the record level seen in September 1990. They have grown by 83MB since March, as the economic recovery has weakened and GDP growth slowed.

Yet in the financial markets, oil is still seen as a bullish story—and oil prices continue to remain at levels that contribute to demand destruction. Cash-strapped consumers simply do not have the discretionary funds to support retail sales etc, if they have first to pay today's prices for gasoline and home energy consumption.

The view in the financial markets, as argued by analysts like Amrita Sen of Barclays Capital, is that "actual demand data had finally started to perform strongly and consistently." But how can an 83MB rise in inventory in the world's largest market be viewed as bullish, especially when other markets also seem to be slowing? China's oil imports, for example, fell by 150kbpd in July versus 2009.

Another sign of weakening end-user demand is that tanker rates are currently at the lowest level of the year. Rates on the major Arabian Gulf/Japan route have fallen 50% since June, and are now at, or below, operating costs. Tanker rates don't usually crash 50% when demand is strong.

Someday, fundamentals will burst the bubble. When they do, and momentum players panic and try to sell in a falling market, it will be users such as those in the chemical industry who have to pick up the pieces.

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