[Editor's Note: Kent released the following report to his Energy Advantage subscribers just a few hours ago. . .But many of your fellow readers here have asked a similar question about the current situation in the energy markets. We wanted to make sure that all of Kent's readers have a chance to see it today. Cheers, James.]
I've received several questions like the one below. It's an important one. . .
Q: Kent, you have predicted $125/barrel oil in July. . .and we cannot even get to $90!!! But you have not addressed anywhere this BIG miss, nor have you provided adequate explanations for it, nor where the real bottom is. (Some forecast $65-$75, and that we could stay in the $60-$90 range until year-end.) It seems to me you gotta take the hit and update on the situation. . .You are supposed to be the energy expert. Thanks! ~ Adrian
A: Adrian, I agree. It's time for a good, hard look at why the oil situation has not unfolded the way I anticipated, and for an assessment of what's happened and the market's new dynamics—including where we stand now and where I believe we're headed next.
Clearly, we're no longer going to see $125 oil by July 1st. Not anymore. (Actually, I had predicted an even higher price—$150 a barrel and possibly, under the right set of circumstances, $200.)
So what happened?
When I made the projection this spring, all the factors were in line for a massive spike in crude oil prices. The strange thing is, most of these factors are still in line.
There are nine indicators I review every day to determine where the price of oil is likely to be.
All nine were pointing in the same direction (up) by March 16, and six are still pointing in the same direction today. But markets have a mind of their own, and the last two months were simply a bear when it came to the energy sector.
There were no fundamental reasons why the slide has lasted as long as it has. A short-term pullback had been in the cards for early May, but I had that bottoming out at an 8% to 9% correction—nowhere near the upwards to 20% we actually got.
Currently, we have a floor that's formed over the past week. And that's a good thing. The longer we can see stability, the better the fundamentals are able to take hold.
Oil itself, however, is still in the grasp of forces that have less to do with the actual dynamics of the oil market and more to do with market emotion (you know, for each dose of "irrational exuberance," there is an equal measure of "irrational pessimism"). So we will see a recovery in our energy stocks first, before we see another rise in oil prices.
The combination of severe concerns over the European mess, the flight to the U.S. dollar (that singlehandedly depresses oil prices), the unusual situation in the bond market. . .They have all contributed to the decline. Mega-trading programs have also moved heavy play into shorting crude oil.
These have been translated into projections of sluggish demand for crude and oil products, and that has added more fuel to the fire.
Projected demand, of course, requires upwards of a quarter's worth of figures. It's not a day-to-day exercise in extrapolating hunches from volume in storage at Cushing, Okla., or stockpiles at refineries. The first is a function of transit, not demand. The second is actually improving refinery stock values, since the stockpiles are a result of buying cheaper crude in anticipation of more expensive crude coming down the line.
The curious thing is this: Surpluses at Cushing and stockpiles at refineries were higher when we were pushing $110 a barrel in New York and $125 in London.
Markets do this. The indicators are all there, but trading decides to move in another direction. Trading exchanges may be among of the most intriguing inventions every devised, but—most unfortunately—they are not always rational.
But there's nothing we can do about that. So where are we now?
Despite all of the negative commentary on oil prices, we know three things with absolute certainty:
- First, both OPEC and the International Energy Agency (IEA) in Paris have reported that international demand (the real driving force of where crude prices ought to be) will be coming in higher this year than the last five. Yes, they have been cutting estimates, but the bottom line is still a recent record.
- Second, the last round of talks between Iran and the six major nations will break up today in Moscow. Nothing has been accomplished, and the EU embargo of Iranian oil will begin on July 1. That fact would have already moved Brent prices higher, had it not been for the ongoing drama on the Continent.
- Third, the euro is now slowly moving back up in value against the dollar. Why? Greece will have a government by this afternoon, Spanish 10-year bond yields are now below 7% (still unsustainable, but better; the more serious problem are the yields on the shorter end of the curve), word is the European Council (the EU heads of state) will sign on to new bailout measures when they meet the end of the month, and continental-wide financial integration is approaching.
Now, Europe will remain just this side of a basket case for some time. But the odds of the 27 EU members returning to local currencies are quite low. Everybody recognizes that the demise of a common currency is a bad idea for everybody (even the strongest of the members, Germany).
What is needed now is liquidity, and that will require longer-term European bonds (whether Berlin and Paris like it or not).
All of this affects the price of crude oil (and other commodities) as futures traders play the spreads to make money. It just happens that, now, it is easier to push oil down than up.
But remember. . .
Our Energy Advantage Portfolio is not a month-by-month proposition. It's designed to take advantage of the most powerful long-term wealth-generating sector in the market.
Of course, when downward trends are aggravated, we will sell shares when they reach their trailing stops—a time-tested sell discipline that will preserve our capital over the long run.
But when the upward trend resumes, our shares will accelerate faster than the market as a whole.
Oil & Energy Investor