Is The Oil Correction Over? Market Shows Some Strength

The pre-market stock futures were flat on 9-1. The U.S. Dollar was mixed. Asian markets closed higher. European markets were lower. U.S. Treasury bond yields were lower. The U.S. Ten Year note was trading with a yield of 4.10% in electronic trading. Crude oil was trading near $42.50 and heading higher. Gold was near $411.

Merrill Blames China For High Oil Prices

Chinese oil hoarding might be keeping oil prices high, according to Merrill Lynch. According to the U.K.'s 'Evidence is mounting that China is buying more oil than it consumes, raising fears that oil hoarding may be supporting the current high price of crude. The signs of aggressive Chinese stockpiling emerge from research by Merrill Lynch, the investment bank, which suggests that China is importing crude and refined products at twice the rate of growth in actual demand.'

The report is interesting, as it puts a damper in the notion that filling the U.S. Strategic Petroleum Reserve is to blame for keeping oil prices high, as some Democrats have said. According to the Timesonline: 'Rampant economic growth in the People’s Republic over the past two years has enabled China to overtake Japan this year as the world’s second largest oil consumer, burning some 6.3 million barrels a day. Projections of the rate of growth in consumption in the People’s Republic suggest that China’s power generators, road haulers, petrochemical plants and factories will burn an extra 500,000 barrels a day of crude oil this year. But Merrill Lynch’s analysis of implied demand, based on import data in the first and second quarter of this year, suggests that demand will increase this year by one million barrels a day.'

The implications are somewhat contrarian. The article notes that 'Michael Rothman, Merrill Lynch’s senior energy analyst in New York, reckons that the second figure is not real consumption and does not reflect actual burning of crude in Chinese cars and power plants.' Rothman says that {'It appears to be a hoarding phenomenon and we think it has to run its course, and when it does pass, prices should gravitate much lower, somewhere down towards $30 per barrel.']

Merrill’s report comes at an interesting time. To be sure, the Chinese oil hoarding theory is fairly unique among analysts. But we note that just as the article was released, crude oil’s correction seems to be over, at least in the short term, as crude futures look to have successfully tested the 50 day moving average. Moreover, oil stocks, see below, look to have begun to turn higher. (See our energy section for new recommendations).

Also important will be what the supply data from the U.S. Department of Energy and the API tell us, when they are released mid morning on September 1.

The Timesonline report notes that ' Hoarding was a major factor in the escalation of the crude price in the late 1970s when Western countries snapped up cargoes fearing shortages following the Arab oil embargo. In recent years, US crude stocks have fallen as oil refiners shift to a just-in-time policy aimed at cutting costs. In December stock levels fell to 268 million barrels, below the 270 million threshold the US Government considers a safe level. Since then American refiners have been rebuilding supplies.'

China, and the U.S., do not seem to be alone. The article notes that 'More signs of stockbuilding emerged three months ago when it transpired that India had bought cargoes of 25 million barrels. ['This volume of oil, almost a million barrels per day for precautionary reasons, is a type of hoarding,'] Mr Rothman said. Data on Chinese consumption was sparse because the country did not provide oil stocks data, so inventories had to be inferred from import statistics, he added.'

As usual, the lack of transparency from China makes life more interesting for analysts. 'Fears about the lack of data has also been highlighted by the International Energy Agency. ['People arrive at Chinese demand by computing derived demand from import and consumption data,'] a spokesman said.'


As winter approaches, oil supply will become a more talked about topic. Although the market has now become more accustomed to the almost daily threat of some kind of attack on Iraqi infrastructure, Russia’s increasingly tense political problems and the recent increases in terrorist attacks there are opening up a new potential set of problems for the oil markets.

Up until now, little attention has been paid to the possibility of a Chechen attack on Russia’s oil infrastructure. The ease with which two airplanes were blown up in mid air on August 24, as we pointed out here recently, suggested that Russian security is not up to U.S., and even European standards.

It doesn’t take a whole lot of imagination to see that Al-Qaeda, either directly or through some Chechen or other group, after being frustrated by U.S. security, could easily begin to target the Russian oil industry.

In our opinion, that is a fear that the market has not factored into the price of crude.

In other words, it is possible that barring a major buildup in oil supply, this could be an expensive winter once the market gets in gear with a whole new set of supply disruption fears.

Oil Roundup

Oil Markets: 50 Day Average Holds Key

Crude oil futures were trading above $42 per barrel on 9-1, in very early pre New York action. Unless something very dramatic happens, our analysis suggests that the correction might be over.

Oil stocks also look ready to make a major attempt to get back to their recent highs. If the oils stocks do not fall apart here, and the futures manage to hold it together, we could be setting up for another run at the recent highs.

The Philadelphia Oil Service Index (OSX) remained just below 110.. A strong close above 112-115 would likely signal a new rally here. A break below 98 its 200 day moving average, could send it plummeting to the 88 area in a hurry. For more details on trading the energy sector visit our energy timing page, featuring our highly effective OIH timing model and our Top Ten Energy Stock List.

The Amex Oil Index (XOI) finally used the 630 level as a launching pad. XOI has persistently remained below the 630 area, again not providing a very reassuring background for the bulls. The 610-627 area is key support, and has been penetrated. This is still a crucial juncture for the entire oil sector, as a continued failure in the near term could lead to a major top forming. A close below 600 would be a very negative technical development. For immediate analysis, including stock picks, and the latest in technical analysis of the entire energy complex, our subscriber section has a full complement of recommendations in oil service and the rest of the energy complex.

Oil On The Rebound

We were among the first services to note that the oil rally was way overdone in the last few weeks.

The oil stocks did not keep up with the rally in the futures.

Some did not agree with us, and noted that in some cases the futures lead the stocks.

Our stance, remains the same. The stocks lead the price of the commodities over the long haul, even if during some periods the connections are not as tight as during others.

And the current action in the stocks, if left undisturbed, is very encouraging for those wanting higher oil prices.

Exxon Mobil (NYSE:XOM) is the bellwether for the entire oil industry. And this stock is near an all time high.

If XOM delivers a close above the $47-48 area, we could be in for higher oil prices, or at least higher prices in the oil stocks.

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