Sources: Oil Glut Building? Oil: $64 Key Support

Today's Analysis: Oil Glut Around The Corner?

Some sources are hinting that a glut in oil is coming, but few are listening. The two sources are not outside the box by any means, which makes the notion quite interesting, especially on the day that oil supply data is likely to move the markets.

OPEC Worries About Overproduction

According to Middle East Newsline, OPEC is worried about overproduction. "OPEC has asserted that oil production by the 10-member organization has exceeded global demand. OPEC president Ahmed Fahd Al Sabah said members have been producing 30.4 million barrels of oil per day. Ahmed, the Kuwaiti oil minister, said this was one million barrels per day over market demands."

The minister added: "This production is more than the market needs to allow the building of strategic and commercial stocks in order to stabilize prices," Ahmed told the official Kuwait News Agency."

Chevron CEO Sees Oil Prices Dropping Below $50

In an oddly timed statement, as Hurricane Katrina was battering New Orleans and the Gulf Coast, Chevron CEO David O'Reilly was telling reporters that supply would eventually overwhelm demand and that oil prices would fall. According to the Wall Street Journal, in an August 30, 2005 little noticed article, "Oil prices above $50 a barrel won't be sustainable in the long run as the current oil spike helps bring supply and demand back into balance, Chevron Corp. Chief Executive David O'Reilly said in an interview Tuesday."

According to the journal, "Mr. O'Reilly, who was in Jakarta for an oil and gas conference, said high oil prices will ultimately curb the world's appetite for oil, including in Asia, where costly government subsidies have so far discouraged consumers from reining in their fuel purchases. At the same time, he said, new oil capacity is in the works that should help ease tight supplies, further reducing the current pressure on global energy markets.

As the market was driving prices higher, O'Reilly noted: "I don't think $70 is sustainable, or $60, or $50," he said. "At these prices, demand growth moderates and there is new capacity coming on."

What makes the statements interesting, is that so far, he's been correct, as $70 has been the price ceiling. More interesting yet, is the fact that "Mr. O'Reilly is viewed as one of the more bullish oil-industry CEOs when it comes to forecasting oil prices. In a new round of advertisements for the company, Mr. O'Reilly proclaimed that ["the era of easy oil is over,"] and it has been widely reported that he believes increased demand from China and India could place new strains on the world's oil supply. Moreover, when Chevron beat out Chinese oil company Cnooc Ltd. recently to acquire Unocal Corp. for about $18 billion, many investors assumed Chevron was counting on oil prices to remain exceptionally high to make the deal make sense."

According to the Journal: "Mr. O'Reilly said he still thinks prices will stay above their 1990s levels. But ["the idea that there is no response"] in terms of reduced demand and greater supply is ["ludicrous,"] he said."

O'Reilly also gave a nod to the notion of peak oil, sort of through the back door. ["Mr. O'Reilly acknowledged there could be some truth to a recent theory that Saudi Arabia, among the world's most critical oil producers, will struggle when it comes to adding new capacity to meet global demand. That theory was advanced in a book by Houston investment banker Matthew Simmons, who argued that Saudi Arabia's output will soon head into "irreversible decline." But "history shows we've been able to access oil and gas that we didn't know was there," Mr. O'Reilly said. He said he had read both Mr. Simmons's book as well as another book that made opposing arguments about the world's ability to find oil. "The truth is probably somewhere in between" he said. "I tend to come out on the optimistic side."]


Two things are important about these unrelated articles.

First, there is no mainstream coverage of either of them, although the Drudge Report had the Middle East Newsline article as a link on its page.

And second, O'Reilly's remarks are particularly cryptic, given the timing, as well as the overall lack of detail as to where the new finds are coming from.

With Congress now holding hearings, and the public focused on the high price of gasoline, we would expect a rising drum beat toward domestic exploration in the United States.

The sources above are not outside the box, but the notion of a potential oil glut is so far out on the contrarian scale right now, that it's worth paying attention to.

The bottom line may well be that Federal lands, in environmentally sensitive and previously off limit areas, such as ANWAR, and places off of the Florida and California coast, are about to be heavily considered.

Oil Market Summary And Outlook: Watching $64 in December

Crude oil futures were trading above $65 in pre-U.S. trading, on the day in which the most important oil supply report in several weeks is due out, since it will have the first supply data including the effect of Hurricane Katrina. A fall below $64 could take prices toward the $50 area, as there is little support below $64.

Traders will be weighing the storm's effect against the release of fuel from the Strategic Petroleum Reserves around the world, while the U.S. Department of Energy is expecting U.S. oil and gas production to return to normal by the end of 2005.

Expectations are for a very large drawdown in inventories due to Hurricane Katrina.

The fly in the ointment remains Tropical Storm Ophelia, which is right off of the Florida coast, and could be on its way onto land by this evening. Accuweather is expecting the storm to possibly turn into a Category 1 hurricane and lists the possibility that the storm could head into the Gulf of Mexico.

It's too early to call for now. But the markets, much as they ignored Katrina, are not paying much attention to Ophelia, yet, although interest is starting to increase.

The current scenario does not guarantee that a top is imminent. But it doesn't discount it either. Considering that the current bull market in oil started after 9/11, and that prices have risen nearly 50% in the last year alone, the trend is now well in place, and the market has had just about every opportunity to price in the worst of the worst case scenario short of the world running out of oil tomorrow.

Markets are irrational, and simultaneously and perversely efficient. With the tabloids falling all over themselves trying to find the highest gasoline prices to put on their covers, and The Drudge Report featuring headlines about gasoline lines in Atlanta, one thing is certain, this is crazy time, that point in the market cycle where any sense of rationality is non existent and price swings are very dramatic. Crazy time, is often the prelude to major break time.

When that time will actually materialize is the question. Whomever can answer it correctly will make a fortune.

From a trading standpoint, this market is now both a technical affair, and a news driven market, with the action in the Gulf the key to developments. Active traders should stick with exchange traded funds, such as the Oil Service HOLDRS trust which offer a good way to participate in the overall trend, but still offering liquidity and allowing for the consolidation of the trade into one position that can be liquidated and sold short when the market turns.

Our very long term opinion on oil has not changed. We are still in a very long term bull market in oil, until proven otherwise. The long term line in the sand, for us, remains $40 per barrel. That means that prices can correct to $40 and we could still be in a long term, secular bull market. If prices were to fall below $40, then the very long term trend will have likely reversed.

The Philadelphia Oil Service Index (OSX) is within striking distance of all time highs, but is in a holding pattern.

The Amex Oil Index (XOI) remained above the 1000 area, a key chart point.

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