Wednesday, July 02, 2008
american oil demand destruction
On Monday (6/30), the EIA reported a gigantic drop in U.S. oil demand....
The size of this drop (down 811,000bpd, year-on-year) is massive. Indeed it's almost enough to wipe out total worldwide growth in oil consumption from 2006 to 2007 (990,000bpd, according to the BP Statistical Review 2008). It is enough to wipe out two years worth of consumption growth from China....
So it strains credulity in the extreme to say Chinese demand is behind the run-up in prices since March. The drop in U.S. consumption in one year (April 2007 to April 2008) was more than twice the rise in Chinese consumption from 2006 to 2007 (325kbd, according to the BP Statistical Review 2008). In other words, the April drop in U.S. consumption wiped out one year's worth of growth from China (325kbpd), Saudi Arabia (149kbpd) and India (168kbpd) combined, and then some.
Furthermore, Chinese demand can't be fingered for price rises in April because Chinese imports were down year-on-year, as I noted earlier...
There's been no serious decline in supply. We're on the same old plateau, and in fact the IEA reports that supply was up considerably in the 1Q 2008....
Put it all together, and the "supply outstripping demand" theory of the feverish price action since March is emanating an extremely fish-like odor. U.S. demand down by a whopping 0.8mbd year-on-year. That's the elephant in the room now.
i was stopped out of my position in DUG @ 26.20 this morning as a function of the bounce. frankly, i get the feeling i simply set the stop too narrowly. one of the most underreported truths about oil today is the glut of heavy crude, the increased production of which has offset the decline in light sweet arabian crude as northern ghawar has gone into decline, compounded by the net oil export problem. as refineries transition to the processing of heavy crudes, the bottleneck will break and supply problems will (in the near term) vanish.
the price of oil will, of course, move in anticipation of this because it has a massive speculative component. for all the model argument from those who believe futures cannot affect spot prices of the physical, the reality is that they do -- and have.
As reported by the New York Times on September 30, 2006 Goldman Sachs significantly readjusted in August of that year the GSCI's gasoline weighting. Index products tracking the GSCI, and representing an estimated $60 billion in institutional investor funds, were forced to rebalance their portfolios resulting in an unwinding of positions. Originally, unleaded gasoline made up 8.75 percent of the GSCI as of 6/30/2006 , but this was changed to just 2.3 percent, representing a sell-off of more than $6 billion in futures contracts.
As a result, gasoline fell 82 cent in the wholesale market over a four-week period, an unprecedented move; and crude oil, which in July 2006 traded over $79 per barrel for August delivery—at the time an all-time record—subsequently fell to around $56 by January 2007.
there's more to be read regarding the considerable role of speculation in setting prices from matt simmons of the influential simmons & co.
moreover, one can be sure that, with the futures curve moving into contango and thereby paying for much of its own storage, additional supply (sweet, heavy or otherwise) is being secreted away by entities (including investment banks) capable of taking delivery -- the oil-storage trade. that supply will eventually return to the market either when prices move higher or as the bubble breaks to accelerate the decline.
when speculative capital finally adds up the consequences of massive demand destruction and the gradual breaking of the supply bottleneck -- or even if it is forced to deleverage by conditions exogenous to oil markets -- the last of the major speculative threads that have dominated the global bull market from 2003 to 2008 -- housing, financials and energy/commodities -- will have broken. that will make debt deflation a lot easier to see.
more broadly, the use of oil can be seen as a proxy for american economic vigor. this sort of severe demand destruction ill portends for economic indicators yet to be released for june. recent assessments of increased risk of a market dislocation could find their trigger here. the most recent, not relayed anywhere in the american press, came from low countries financial giant fortis.
Fortis expects a complete breakdown of the American financial markets within days or weeks. This explains, according to the bank insurer, the series of interventions on Thursday with the aim of strengthening themselves by € 8 billion. "We are ready at the last moment. The U.S. is doing much worse than we had thought,” said Fortis chairman Maurice Lippens, who insists that CEO Votron shall not be replaced. Fortis expects bankruptcies among the 6,000 U.S. banks that have low coverage. "But the same goes also for Citigroup and General Motors, and thereby starts a complete meltdown in the U.S.”
i would not be surprised to see a sudden and unanticipated worsening of economic conditions in june translated into a deeper leg down in equities and corporate credits both -- one which finally offers the spike in traditional fear gauges that many market watchers are questioning the absence of.
UPDATE: i revisited the technical outlook for the dow jones US oil and gas index (the 2x inverse of which is DUG) and decided to re-establish the position -- actually in larger scale -- with a lower stoploss. and just in time? in spite of oil reaching a new all-time-high at $144, DUG is outperforming both QID and SKF today.