Oil is down at $113 pre-market despite a new hurricane (chart thanks to Trader Mike).
That is fabulous news and, if that sticks through the day, it will be our best chance to turn this puppy around again. Commodities in general are turning down on a rising dollar and declining global demand that is not going to be reversed just because Olympic driving restrictions have been lifted in Beijing. Commodity investors have been operating in a very special fantasy land based on hope: They hope for shortages, they hope for war, they hope for terrorism, they hope for natural disasters, they hope for price manipulation by OPEC or the US oil cartel or NYMEX crooks and they hope that people are so dumb that they will continue to buy petroleum products no matter how outrageous the price gets.
While a lot of those things happen some of the time, they don't happen all of the time and, in the course of this ridiculous run since Jan '07 from $50 to $147, they have burned up every one of those excuses at one time or another to add another $5 to the price of oil. Unfortunately for energy bulls, what they have now done is set a price premium that can be defined. What happens now when OPEC doesn't cut production? Down $10. When a hurricane doesn't come? Down $5. When Nigerians don't blow up a pipeline this week? Down $5. When they can't create a draw in the weekly inventories? Down $5… etc.
Now the oil companies are at odds with the refiners, who are not dropping consumer costs of refined product as fast as the cost of a barrel of crude is falling so demand destruction is proceeding apace despite the 30% pullback in the price of oil since the disastrous July 4th NON-driving weekend. In fact, had it not been for the stimulus checks, which were effectively Bush's thank-you gift to the oil thieves as they allowed the record run in crude to happen (oil was $100 before this mad scheme was unveiled), gas purchases would have fallen right off a cliff this summer – the same cliff they are now diving off now that people have to spend their own money on fuel.
I wrote my article entitled "$200 Oil – Who's Going to Pay For It?" in response to Goldman's ridiculous call that oil would hit $200 this year. That was March and, since my former CEO wasn't running the Treasury, I had no idea at the time that the government would be footing the bill for a massive spike in oil. At the time, oil was below $100 a barrel and too high at that price and clearly people were running out of money (see article for all the math). In order to pay $150 a barrel for oil, US consumers need $3Bn a day. If we assume $70 is the real price of oil then $150 oil needed Americans to fork over an extra $1.6Bn per day. What a coincidence than, that a stimulus of $160Bn was just enough to cause a 100-day run in the price of crude…
Now we are back to reality and cash-starved consumers must allocate their spending and, as you can see from the above chart – again and again fuel consumption is being sacrificed in favor of fun things like paying off debt. When gas was $2 a gallon, not going to the shore for the weekend would save you $30 and wouldn't seem like a reason to skip the trip but at $60, suddenly it becomes a factor. The problem for the oil pushers is they lose not just the extra $30 but the original $30 they would have gotten had people taken the trip – that's demand destruction!
China is skirting the effects of demand destruction because their fuel is subsidized but Sinopec just reported a 77% decline in net profit as the subsidies eat into their margins and PTR also reports this week and is expected to show similar problems. Now that the Olympics are over, the next shock for oil bulls iis likely to be China's RAISING of fuel prices and even 10 cents a gallon is a lot when the average person in China makes just $2,400 a year.
Oil is sucking the life out of the entire global economy, the MSCI World Index we discussed in yesterday's post dropped another 0.8% yesterday, now down 17% for the year yet the EIA continues to project bullish global growth in demand for crude despite evidence of declines in many countries besides the US. “The economic outlook is very negative,'' said Gregor Smith, a London-based fund manager at Daiwa Asset Management, who helps oversee $1 billion. “If we continue to see economic weakness, then corporates will continue to cut spending. Uncertainty over global demand and high energy prices continue to make the market nervous.'' The Ifo institutes' business climate index declined to 94.8 in August from 97.5 the previous month. Economists had predicted a drop to 97.2.
Fortunately, thanks to a boom in shale production, natural gas production is up 8.8% this year, the largest increase in production since the drilling boom of 1959. Natural gas prices have dropped 42% since early July, outpacing oil on the way down (so far). “Production is clearly growing, and the growth is sustainable,” said Michael Zenker, a natural gas analyst at Barclays Capital. A Deutsche Bank report, by the analyst Shannon Nome, recently estimated that production from the eight largest shale fields was likely to hit 6.6 billion cubic feet a day this year, or 11.8 percent of national gas production, and then rise to 14.5 billion cubic feet a day by 2011 — almost a quarter of domestic production.
“Shale is the most significant domestic natural gas find in 50 years,” said Chris Ruppel, an analyst at the institutional brokerage firm Execution, “which means the United States will become gas independent, and more industrially competitive versus Europe for gas-intensive industries such as chemicals, fertilizer, smelting iron and aluminum.” With the growth of power generation from natural gas, the Energy Department estimates that gas consumption will increase 3 percent this year and an additional 1.7 percent in 2009. But that is well below expected supply increases. So not all is dire in the energy picture, right T Boone?
Asia held up surprisingly well overnight with the Hang Seng dropping just 48 points and holding onto 21,000. The Nikkei fell below 12,800 with a 100-point decline and Shanghai continued to tumble, dropping another 3.4% on the day. The good news for the Shanghai is that 3.5% is half the point drop it used to be – see, there's always a silver lining! The IMF cut 2009 global growth forecasts to 3.9%, down from 5% last year and 4.1% this year.
Banks led Europe lower this morning as the Euro tumbled to a 6-month low on news that German consumer confidence fell more than forecast, to a 3-year low of 94.8, down from 97.5 in July. At the same time, German business expectations fell to 87, the worst measure since the 1993 recession. The German economy contracted in the second quarter and may enter an official recession if there is no growth in the third. “The deterioration of the outlook in Germany is showing no sign of stabilization,'' Maxime Alimi, an economist at Lehman Brothers International in London, said in a research note. “The risks of a technical recession are certainly rising.''
Unfortunately, in the time since I began writing this article, oil has ticked back up to $116 on the hurricane news as well as official Russian recognition of the Georgian satellites (9am) and that does not bode well for the US open either. We still have a very tight inverse correlation between the price of oil and the Dow's performance and if we are going to get this market off the floor oil MUST go lower. We have our own consumer confidence at 10am along with New Home Sales (expected 525K) and Fed minutes at 2pm so plenty of fun data to swing the markets back and forth.
We need to watch our Big Chart levels that we discussed last night as it is critical we hold the line on the S&P at 1,261 as well as 12,350 on the Dow. Let's look for ths SOX to retake a still-pathetic 361. That $115 line in oil is still critical too but if we can't beat them we can join them by picking up some XOM $80 calls at $1.60 as a momentum play but we need to give up at $1.25 to the downside, looking for $2.20+ so a really quick play.
Other than that, we either hit our lower levels and start to cover up and roll down or we hold the line and sit back for the ride – it's going to be a bumpy one for sure!
