Stocks Held Hostage By Oil

The pre-market stock futures were moving lower on 6-3. The U.S. Dollar was mixed. Asian markets ended negative . European markets were falling but had come off their worst levels. U.S. Treasury bond yields were higher. The U.S. Ten Year note was trading with a yield of 4.71% in electronic trading. Crude oil was trading above $40. Gold was above $390.

The major influences on the markets are the Iraq situation, the price of oil, and the increasingly tight situation in Washington, where amidst a tight election, major political developments continue to unfold.

OPEC Out Of Options

The oil markets will likely have a mid morning reaction on 6-3, as the one day delayed API and Department of Energy will be released. According to multiple sources, expectations are once again for supply buildups in gasoline and crude oil. This of course sets up the potential for a big move if there are any surprises, a standard set of expectations to have on supply report day.

It's the best of times and the worst of times for OPEC. As long as the price of oil remains near $40 per barrel, the cash flow for the cartel is at record highs. But, even OPEC knows that commodity rallies eventually end, and most often with a crash.

To be sure, this is not an ordinary time for crude oil, given the fact that U.S. refinery capacity is not going to grow anytime soon, and that many OPEC countries are at maximum production capacity already.

But several other factors have to be considered. Even if OPEC raises production, by the purported 11% being floated as a benchmark, it would take time to get new oil to the refineries, meaning that it could be several weeks before new gasoline actually hit the pumps.

Also important is the fact that Saudi Arabia is now in a state of open war against Al-Qaeda with the oil industry being the focus. According to "Perhaps the most serious aspect of the situation (in the oil market) is the growing uncertainty surrounding the future of the Saudi oil supply, a supply that is contingent upon the continued presence of Western workers manning key positions in the Saudi oil industry." If foreign oil workers in key positions abandon their jobs, it could be a significant set of dominoes that begin to fall.

Stratfor also makes other important points:

  1. "Although OPEC faces increasing demand, production has almost reached its maximum. The cartel will do what it can to keep crude prices down, but its options are limited. With the factors underlying high prices unlikely to change soon, OPEC's decision will have little impact on the price of oil."

  2. A "near-term increase is achievable, but sustaining a higher output will prove difficult. Only Saudi Arabia and the United Arab Emirates have the excess capacity and infrastructure required to maintain the increase. Saudi Oil Minister Ali al-Naimi said June 2 his country is willing to raise production by 2 million bpd, bringing the Saudi total to 10.3 million bpd. That same day, the UAE announced that it will raise output by 400,000 bpd to bring production just above surge capacity. These two nations could raise OPEC's production by approximately 2.5 million bpd."

  3. And the most ominous point from Stratfor's OPEC analysis is this:

  4. Qatar has surplus capacity but cannot support a sustained surge in output. Venezuela cannot support a supply increase, due to mismanagement of production procedures and finances, and Indonesia is simply running out of oil. Although the remaining OPEC member nations can boost production for a short time, they have no real reserves to maintain increased output.

If Stratfor's analysis is correct, we could be in for sustained run of oil prices near the $40 per barrel range.

But, the oil stocks continue to diverge from the price of crude, creating a major technical divergence. This is most obvious in the oil service stocks.

The Philadelphia Oil Service Index (OSX) continues to struggle, remaining below the 100 area, but has remained below its 50 day moving average and above its 200 day line. A break below 94.75 could send it plummeting to the 88 area in a hurry. 110 is still key resistance. The index did successfully test its 200 day moving average, but is still clearly diverging from the price of crude and predicting some kind of pull back in the market. 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) has been more resilient, and managed to close above 610, and above its 50 day moving average, despite the pull back on 6-2. 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. 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.

Our own conclusion remains that as long as the oil stocks don't confirm the new highs, it is doubtful that prices can be sustained at record highs. That they fluctuate wildly is more likely.

In the Rigzone Store:

Successful Energy Sector Investing: Every Investor's Complete Guide

Dr. Duarte's book predicted many of the current developments in the economy and the energy markets, and provides an excellent set of benchmarks and trading lessons for what could be in store for the future.