Oil: A Second Quarter Issue

The pre-market stock futures were moving slightly higher. The U.S. Dollar was down. Asian markets closed mixed. European markets were mixed. U.S. Treasury bond yields were rising. The U.S. Ten Year note was trading with a yield of 4.23% in electronic trading. Crude oil was trading above $37. Gold was trading above $420.

The second Quarter of 2004 brings a new set of worries for investors. And while bull markets climb walls of worry, the issues are nevertheless increasingly serious, especially in an election year.

And while the mainstream media worries about the blow by blow of election year politics, we delve beneath the obvious, while still noting the latest polling data, and focus today's article on the energy markets.

Energy Market Update: These Are The Good Old Days For The Price Of Gasoline.

Our energy market forecast for 2004 was one of oil prices between $25-35 per barrel, and a general adherence to seasonal tendencies.

So far, we got it more right on price, but not on the seasonal tendencies, meaning that the usual fall in prices in the spring, has not materialized. And both factors are sending ripples of bad news for businesses and consumers.

Crude oil and natural gas prices are expected to rise for the rest of 2004. According to futures for the months of June, September, and December, crude oil, as of 4-8 was pegged at delivery prices above 36, 34, and 33 dollars per barrel, well above the 30 dollar range and over three times the low price of $11 at the bottom of the cycle in 1998.

More interesting is the fact that natural gas prices, for the same delivery months closed last week above $6. Even more daunting is the fact that while crude prices were some 10% lower for December delivery, natural gas was some 5% for end of year 2004 delivery.

The most recent supply figures from the U.S. Department of Energy and the API, showed that U.S. supplies are historically low. Gasoline prices keep creeping higher, making new all time highs. And the call from Washington for investigations into fraud from oil companies has died down. Frequent readers are familiar with the concept that once Congress starts holding hearings on high gasoline and oil prices, the top in prices is either close, or has already happened.

Aside from the fact that OPEC is playing hard ball, and talking prices up, global economies are no longer contracting. There is also a natural gas squeeze in South America, with Argentina and Chile finding themselves in a difficult situation during the toughest part of their winter.

Stratfor.com notes two important reasons, which make this energy cycle different than others, for the U.S.:

  • A weak dollar: "All international crude contracts are settled in U.S. dollars -- and with U.S. currency roughly one-third weaker than a year ago versus the yen and the euro, anything oil-based is proportionally more expensive in the United States than in Japan or Europe." The dollar may have made an intermediate term bottom, and could begin to rise, though, if the U.S. economy continues to grow, interest rates continue to creep up, and if the Iraq situation begins to make progress.

  • Venezuela: "Problems in bringing Venezuelan crude to market will threaten U.S.-based Gulf Coast refineries and likely will have a subsequent effect on U.S. gasoline markets. Caracas claims production of 3.1 million bpd, but the IEA pegs the actual figure at just below 2.6 million bpd. The primary problem is twofold. In the aftermath of the strike in late 2002 and early 2003, the Chavez government purged state oil firm PDVSA, firing nearly all of its engineers and technocrats and replacing them with people whose forte was political loyalty, not oil production. The government also has been fleecing the firm in order to pay for social programs that will increase its popularity."

  • For the United States, this may be as big a problem as any other, since Venezuela is the number four supplier to the U.S. and is the owner of the CITGO retail outlets and refineries.

    Stratfor notes that Venezuela's oil industry is extremely sensitive to the amount of money that is invested in it on a year basis. Thus: "because Venezuela's investments have fallen behind, production declined 20 percent in 2003 -- and still can fall further. The last time Venezuela suffered a prolonged investment dearth, production plunged from the country's 1970 high of 3.7 million bpd to 1.7 million bpd in the mid-1980s."

    Bottom line here: as we have noted before, even if politicians and pundits hail a fall to the $30 price range in oil, it is just a cosmetic drop. And their acquiescence just means that the bar has been raised yet again, toward a higher plateau in the price of oil and gasoline.

    In plain English, this means that just as we once wished for $1.00 per gallon gas after the 1970s embargo and after shocks, someday, we'll all look back fondly at $1.50 per gallon gas.

    Energy And Tech Stocks Suggest Strong Economy Well Entrenched.

    In our book Successful Energy Sector Investing: Every Investor's Complete Guide we described a relationship between the energy and technology sectors, which proved the link between both sectors and a strong economy.

    The current market is providing such a picture, albeit without the traditional tech bellwethers leading the way.

    Nevertheless, it is worth noting, and monitoring.

    Occidental Petroleum (NYSE:OXY) is a good proxy for the current energy market. The company has excellent levels of proven reserves, and is a major player in the petrochemical sector, which insulates it from the influence of gasoline prices.

    Also important to keep in mind is that petrochemicals, are highly economically sensitive commodities, and often serve as bellwethers of future trends.

    And while Intel and the usual Nasdaq large cap stocks are struggling, software and productivity companies with wireless connections are doing well, and seem to be the engine of growth in the current tech sector.

    A perfect example is Palm One (NNM:PLMO), the recent spin off from Palm Inc.

    Both Oxy and Palm are in well established up trends.

    Taken together, these shares are telling us that the U.S., and thus the global economies are no longer on the mend, but in established up trends.

    Neither the public at large, or the market seem to have grasped that possibility fully, as of yet.

    The Philadelphia Oil Service Index (OSX) is still consolidating, and could make a move any time, since it has been consolidating near the 100 area in the last few days, and the energy markets are showing signs of tight supplies and increasing demand. The index was oversold, recently, and bounced back, after having lost 10% of its value since the beginning of March. The index had until recently remained near 110, but its break below 100 signals that the top is now in for energy. Whether this is a signal that the energy sector has made its seasonal high remains to be seen. A long term move, if this move regains momentum could take the OSX to 140. The index rallied smartly on 1-20, and has reached an important resistance level, but had remained flat. 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) may also be ready to move. XOI is still testing the 590 area, with the 600-610 area now becoming a very important trading range. A failure in the near term would be supportive of our thesis that the top in energy may have been made. 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.

    To subscribe to Joe Duarte's Market IQ Report Click Here.