Bottom Spotting (Or, yet another way to tell if we’re wrong)

Our story so far: Several weeks ago, we noted that Oil was potentially topping in the $57 – 59 area. Our concern was that a small
counter-trend rally in oil might trap investors into thinking the run was over.
If Oil resumed its prior trend, the unwary might find themselves trapped.

Since then, events have been unfolding as if according to a
script. Even our previous expectations of Oil entering a “Stupid phase” have been rewarded when a competitor projected a possible
“super-spike” to $105.

We find this extremely Crude scenario wanting in analytical
. Barring an unpredictable external event (i.e., terrorism or an invasion
from Mars), we seriously doubt that Oil could reach that level on its own. Why?
About halfway there, the high price of energy would grind the global economy to
a full halt. If $55 oil is a drag on the economy, then prices some 50% higher –
$75 to 80 – would act as a financial parachute. The deadweight economic drag
would reduce demand to the point that Oil prices would beat a hasty retreat
from those levels.

Regardless, we find it prudent to war game scenarios that
disprove our thesis. Not as an act of contrition, but as a way to validate or
disprove our expectations. Previously,  we noted 3 ways that could happen:

1) a faster than expected sell off, reaching
very oversold conditions;
2) a break out to the upside over March 7 highs on
strong volume;
3) a series of improving economic data showing inflation free

A fourth signal would also make our Bearish posture
unwarranted: William O’Neil’s Confirmation day.

We find it a reliable way of telling when a sell off has
been exhausted and broken. O’Neil noted the significance of days when the
Markets “follow-through” with a strong rally (up 1-2% or greater), on better
than average volume. This confirmation day ideally shows up in the 4th through
7th day following the first day of higher trading (post-reversal). The big
rally last week was on Wednesday, so we are now on confirmation day watch, from
Tuesday (4/5) until next Monday (4/11).

Barring a big follow through day, our Bearish expectations
remain. Perhaps oil rallies to the high end of our price range ($57 – 59), or
even surpasses it slightly. Beyond that, however, we are most doubtful, as
Crude is becoming an increasingly crowded trade.

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  1. bear2 commented on Apr 4

    I’m with you guys on crude being overbought at $57-$58/bbl.

    I heard today that the US Federal Reserve is almost full. Up to now, it was filling at a rate of 250,000 bbl/day. When it is done filling, there is going to be a surplus of 250,000 bbls/day that wasn’t there before.

    Another thing: this is the time of year when refineries change over from winter heating oil to gasoline. As a result, they are out of production a bit. Expect larger crude inventories in the next inventory report.

  2. fatbear commented on Apr 4

    Since the oil thread has moved up the list, I’ll just repeat what I posted a few hours ago on the earlier thread

    One factor not noted so far – when oil hit its highs last year, the 2009 contract stayed around $40 – this time, it’s over $50 – everything out to 2011 is $50 or over (or within cents of there) – it may be irrational exuberance, but the run up is wider this time

    just to add that 2011 settled at $49.88, and 2010 over $50

    This does not mean those prices are here to stay, but that any expectation of a drop to under $40 is probably unrealistic – at least until the housing bubble bursts – having said that, if 2011 drops below $44 I’m selling my BPT – the price is too good to let it sit

  3. bear2 commented on Apr 4

    I don’t think anyone has done any technical analysis to support a constant price of $40 to $50/bbl out to 2011.

    For one thing, consumer demand can change a lot between now and then.

    For another thing, there is no lack of oil in the world. There is this place called Fort MacMurray, Alberta, north of Edmonton that has a trillion barrels of oil in the form of tarsand. The finding costs on it are near zero. It just has to be minded, recovered and refined. The current cost of doing that is about $28/bbl. Anything above that is pure profit. Suncor, Shell, PetroCanada all have plays there. By 2010 that area will be producing about 5M bbl/day.

    Another thing: there is no shortage of oil right now. The companies that are producing it are just demanding a premium. If there were a true resource shortage of oil, there would be very little profit between the price of oil and the cost of producing it. Right now there is a HUGE price differential, thus the HUGE profits that the oil companies are reporting right now. Yes, the major oil companies are having trouble replacing their reserves, but that is because they don’t have entrepreneurial drilling programs. The Junior oil companies do have good drilling programs and they have good reserves.

    If you are really looking for cheap oil, check out what petrokazakhstan is doing. Their finding costs are about $1/bbl and they are just getting started. If you gave a company like that lots of land, we’d be swimming in oil.

    Another thing: for many years oil companies couldn’t justify extensive drilling programs because there was no price differential between the market price and their production cost. Market was at $20/bbl and their production cost was $15/bbl. Now that the market price is at $50/bbl, they can bring a lot more oil on to production.

    The same thing will go on the demand side. For years the only thing GM could produce was a big 3800lb 200+ HP V6 car with an automatic transmission at best or an SUV with a V8 at worst. Corporate average fuel economy numbers haven’t really improved in years. That will change now that consumers have to pay a realistic price for gasoline.

    Why doesn’t anyone in the US drive a manual transmission car ? They get better fuel economy. What about a diesel car ? Have you been to Europe lately ? Fuel economy matters over there and their cars kick *ss, diesel or not.

    I think that $50 oil is just a wake up call and a good one at that as far as I am concerned. The market will adjust over the longer term. I’ll bet that oil drops down to $30 again.

  4. bear2 commented on Apr 4

    Sorry for the spelling mistakes. I spelled “mined” as “minded”.

  5. mh497 commented on Apr 4

    Petrokazakhstan as in this Petrokazakhstan?

    Let’s hope they don’t get the same lawyers as the OAO Yukos gang.

    If that’s our big hope, we’re ^&%$#@*.

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