Crude oil is sending more mixed signals than a drive-through traffic school.
Basically, it’s boiling down to this: Should I believe crude oil’s fundamentals, or my own lying eyes?
Let me show you what I’m looking at, and maybe you’ll have some thoughts to share.
I can think of plenty of fundamental reasons why crude should go lower. The problem is, the chart of crude itself looks bullish.
Looking at the chart, I can see an obvious inverse-head-and-shoulders pattern in crude oil. That looks bullish, or it will be if crude oil can stay above $97 or $98. (Oil traded as high as $98.25 Friday.)
Maybe it’s TOO obvious. Still, my “lying eyes” would tell me that crude is poised for a potential breakout.
Looking at that chart, you might think that crude oil supply has been getting squeezed since mid-April. That’s not the case at all. Let’s look at a chart of crude oil inventory from Bespoke Investing …
You can see that America’s crude oil inventories are way above average for this time of year.
Last week, traders expected stockpiles to decline by 1.5 million barrels, but the actual change was a BUILD of 2.52 million barrels. Gasoline inventories also saw a larger-than-expected increase.
Now, combine this with news of weakness in the emerging markets. Why the heck, then, is the price of crude above $90?
The bulls will make three points …
Bull point #1: Seasonal Draw-downs. If crude follows its seasonal pattern, we can expect crude oil stockpiles to start declining through the rest of the summer.
Bull point #2: Higher Demand Forecasts. Last week, the Energy Information Administration raised its 2013 and 2014 global oil demand forecasts. The EIA upped its 2013 oil demand forecast by 99,000 barrels per day (bpd), to 90.03 million bpd, and its 2014 demand forecast by 82,000 bpd to 91.22 million bpd.
Bull point #3: Stormy Weather. Finally, we’re heading into hurricane season, and that brings with it the possibility of supply disruption in the Gulf of Mexico.
On the other hand, the bearish fundamentals are actually quite strong. Here are some of the points the bears are making …
Bear point #1: The EIA Based its Higher Demand on Asia, Particularly China. Have you seen China lately? Its growth is slowing down.
Source: Business Insider/Bloomberg
Chinese industrial production, which measures output at the country’s factories and mines, rose at a slower pace than during the previous month. Meanwhile, fixed-asset investment also came in below expectations. At the same time, China’s exports are slowing down and its imports dropped.
The fact is, China is joining India in the camp of slowing economic growth. To be sure, both countries are still experiencing economic growth — but not as fast as we are used to.
China’s annual economic growth slowed to 7.7% in the first quarter from 7.9% in the previous quarter. China’s full-year annual growth of 7.8% in 2012 was the weakest since 1999.
Looking ahead, the International Monetary Fund and Organization for Economic Cooperation and Development cut their forecasts for China’s 2013 economic growth to 7.75% and 7.8%, respectively.
And while the U.S. EIA says China’s oil demand will increase, the International Energy Agency (IEA) thinks otherwise. “There are mounting signs that China’s oil use, like its economy, may have shifted to a lower gear,” according to an IEA statement.
Bear point #2: OPEC Said Production Increased a Bit in May. In particular, Saudi Arabia increased output, pushing up the monthly output 100,000 bpd to 30.57 million bpd. That’s more supply on the market, which should weigh on prices unless demand rises.
Bear point #3: U.S. and North American Oil Production is Booming. The U.S. pumped 7.3 million barrels a day of oil last week. In fact, the U.S. has been pumping 7 million barrels a day or more of oil since the week of Jan. 4.
America is now producing more oil than it imports — the last time that happened was in January 1997.
In fact, net U.S. crude imports fell by 437,000 bpd last year to 8.5 million bpd, the lowest level in 15 years.
In the bigger picture, annual data released last week by the U.S. Department of Energy showed domestic crude production rose by 812,000 bpd last year, the fastest annual increase since the dawn of the American oil industry.
Meanwhile, Canadian crude oil production is expected to more than double to 6.7 million bpd by 2030 from 3.2 million bpd in 2012, according to data from the Canadian Association for Petroleum Producers. This includes oil sands production of 5.2 million bpd by 2030, up from 1.8 million bpd in 2012.
As for Mexico, its crude oil production is gradually declining. But the Mexican government hopes landmark energy reform will lure major investment in private oil to help boost output.
Go for the Bargains
So, I’m in a quandary. The big-picture fundamentals seem bearish, but the chart action looks bullish. What do you make of it?
Here’s what I make of it: I don’t know where the price of oil is going to go. But it all has to go somewhere — it all has to be transported. That tells me to look at two kinds of potential winners.
- Pipelines: Many pipeline operators got shellacked recently when investors dumped those high-yielding companies as bond yields rose. That’s a buying opportunity, and I plan to make the most of it.
- Railroads: Pipelines are so stuffed, a lot of oil travels by railroad now. We already have a nice play on this in Global Resource Hunter, and I’ll look to add more.
One Group to Avoid
There is also one industry I will avoid: oil tankers.
Due to U.S. laws, our crude can’t be shipped overseas (refined product is another matter). So, this boom in North American crude oil production is not a boom for oil tankers — at least not yet.
Stay tuned. The laws — and the opportunities — could change quickly.
All the best,
Sean Brodrick & Brad Hoppman