Oil Crisis Ahead?

OPEC is out of spare production, while China is projected to increase its oil demand by 25% in 2005. If this scenario is correct, the current pause in the oil rally may be temporary.

The International Energy Agency stalled crude oil’s fall in Europe overnight, as it predicted that China’s oil demand will increase by 25% in 2005 to 500,000 barrels per day. According to the Financial Times “the revision was based on forecasts that US economic momentum would last longer than previously expected, which would help China sustain manufacturing exports. The IEA also said China was clamping down on construction of non-approved, chiefly coal-fired power plants. Persistent power shortages boosted demand for gas oil and residual fuel oil, but the IEA felt this situation would probably not get much worse.”

The IEA based its forecast on two facts: 1) continued U.S. economic growth, and 2) continued export strength from China due to 1).

According to Bloomberg‘s take on the IEA report: “Oil consumption will be 84.3 million barrels a day this year, 330,000 a day more than last expected. Use will rise 1.81 million barrels a day, or 2.2 percent, the Paris-based agency said in a monthly report today.”

Here is where it gets interesting. According to Reuters: ["OPEC does not have the production capacity to increase its quotas,"] Algeria's Energy Minister Chakib Khelil said on Thursday. OPEC raised supply last year to the highest level in 25 years, leaving little spare production capacity to cope with output disruptions.”

Bloomberg added: “Industry stockpiles of crude oil, gasoline and other oil products held by nations of the Organization for Economic Cooperation and Development fell by 3 million barrels in January, to 2.573 billion, enough to satisfy demand for 51 days. The days of so-called demand cover were unchanged from December even after the higher consumption forecasts, the report said.”

The IEA report was in conflict with data released one day earlier. According to Dow Jones Newswires: “China's imports fell in February for the first time in three years, while producer-price data showed that inflationary pressure is abating, according to official figures issued Thursday. China's imports of crude oil fell 12.7% from a year earlier to 2.26 million barrels a day in January and February, figures from the General Administration of Customs show, contributing to the overall decline in imports in February.”

There were other signs of moderation, or at least a shift in China’s economy. “China's trade position swung to a $4.62 billion surplus in February from a $7.87 billion deficit a year earlier. China's producer-price index rose by its slowest pace in 10 months while growth in lending and in M2 money supply also continued to abate. M2, China's broadest measure of money supply, measures all cash in circulation and all savings, including those held in deposit accounts by securities brokerages.”

Supporting the IEA’s prediction though, Newswires added: “Exports rose 30.8% from a year earlier to $44.53 billion, while imports fell 5% to $39.92 billion, the (China) Ministry of Commerce said on its Web site.”

The boom in exports may be mostly related to a jump in textiles, which is becoming a point of contention with Europe and the U.S., as Chinese textiles are flooding the market after quotas in place for years were removed.


Today’s analysis is linked by two threads, expectations, and contradictions.

The IEA is expecting a boom in oil demand from China, while China is cooling off its economy, and interest rates are rising in the United States and around the world. Something has to give here. Is China suddenly becoming energy efficient, where it can cool off its economy and at the same time use more oil to produce more goods for exports?

Or are the Chinese economic statistics lying? In other words, is the IEA basing its forecasts on bad data? In a country where the government owns the private companies that it is steadily privatizing and peddling onto global stock markets, you have to take much of what they put out with a grain of salt.

In other words, the Chinese government is financing its own operations by selling stock to the world. Just as Worldcom and Enron told as many people as would listen that everything was all right until the end, the Chinese government could theoretically be using the same kind of tactics. These are the same guys, essentially, that gave us Tiannamen square, and scores of bank scandals, government fraud, denials about SARS, as well as concealing a widespread AIDS problems for years before admitting that they had one.

That means, that we really don’t know what the real situation is in China, and that at some point, just as with the China Aviation Oil situation, and the other numerous instances of a lack of full disclosure and flim flam, something bad could pop out and create significant problems.

Next, the FBI can’t find any sleeper cells in the United States, defying a consensus that believes that there are numerous such organizations that are alive and well. But, we know that U.S. money is laundered and makes its way to bad guys all over the world. So why bother with this report? If we had found any sleeper cells, we would have heard about it, unless the government is trying to create some kind of sting operation or keep the public from having a collective panic attack.

More interesting is the fact that terrorist organization rankings are changing, as Hizbullah is steadily emerging as the global kingpin, despite Al Qaeda’s notoriety.

The oil situation, despite what the mainstream media is putting forth as its mantra, is not a demand issue. It’s a supply issue, and a refining issue.

OPEC is producing as much oil as it can muster now, and is basically maxed out. Tanker capacity is also strained. And refinery capacity in the U.S. is also maxed out, with no prospects of a new refinery being built on the horizon, due to environmental and political concerns.

Here is where it all comes together.

If interest rates rise enough, the Chinese economy could grind to a halt. OPEC won’t be able to put on the brakes on production fast enough. And all that oil that is on the high seas and in storage tanks, will sit there, and slowly work its way through the system. A global recession could easily follow, and an economic decline of significant proportion, similar to the Asian crisis of 1997 is a likely scenario.

Hizbullah is a different animal than Al Qaeda. It’s a politically savvy, well financed organization fueled and maintained by the Iranian government. It’s not going away, and it holds parliamentary positions in Lebanon and Syria.

And just because the FBI can’t find them, it doesn’t mean that the sleeper cells, or people that want to do the U.S. harm aren’t there. Timothy Mc Veigh was a non entity until the Oklahoma City bombing took place.

Our point is simple. We don’t know everything. Projections, such as the IEA’s are just guesses. Sometimes they are good, and sometimes they are bad. Things are not static. They tend to move in spurts, fits, and starts. But, they are quite fluid.

The oil market is now at a crucial juncture, as is Hizbullah’s emergence onto the world scene, not as a terrorist organization, but as a well organized group of politically savvy operators with international posts and the ability to make at least some things happen, at some point. Keep an eye on Lebanon.

Think of China, oil, Hizbullah, and Al Qaeda as things lurking in the shadows, waiting to do something. If one of them makes a move, it could be significant. If more than one, or all of them strike within close proximity of each other, things could get very nasty in a hurry.

And if interest rates are rising at the time one of these lurking issues surfaces, the financial markets would not be in a good mood, probably for a long time.

Oil Market Summary And Outlook: Are Lower Prices Coming?

The IEA told the markets that Chinese demand for oil would rise by 25% in 2005. Prices stopped falling in Europe for a couple of hours and started drifting lower. That is a significant shift in perception, and suggests that the markets will need a new reason to rally in the short term aside from demand.

We think that the reason is higher interest rates and their potential to actually cool economic growth with less effort than in previous cycles.

Our premise is simple. After 9/11, the Fed flooded the world with dollars. The world got hooked on easy money. As the Fed pulls the punchbowl away, because of international economic imbalances, especially Japan’s essentially zero interest rates for over a decade, the markets are used to easy money.

That means that a smaller amount of tightening has more of a dampening effect on the global economy than in previous economic cycles.

If we’re correct, the oil markets are starting to price in decreasing oil demand based on expectations of a slower economy.

In other words, OPEC, now pumping at full capacity, could have a surprise on its hands if economic figures start to show weakness, rather than strength as the majority of economists and central banks are predicting.

The flip side is that the market is just cooling off after a huge rally, and that we’ll be back to the races after a consolidation phase.

Oil stocks have made a short term top until proven otherwise, though.

The Amex Oil Index (XOI) is so over extended that it could still fall 10-20% and still be considered to be in a long term up trend. That means that we could be starting one of those refreshing pauses, as we did earlier in 2005, before things got launched to new highs.

OPEC will be meeting on 3-16, and faces a dilemma, whether to cut production now, and risk a price escalation in the short term, or to keep pumping near full capacity and risk a glut at some point in the future, when demand slows.

The Philadelphia Oil Service Index (OSX) fell on 3-10, extending its losses. Volatility will likely increase here in the next few days. 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) also fell, although a pull back was clearly in the cards, due to the recent run up in the energy sector. XOI remains above the 50 day moving average, preserving an up trend. 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.

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