Oil Can't Sustain This Week's Rally, Natural Gas Falls Again

After rallying for four days, the price of oil fell more than $2 in trading on the New York Mercantile Exchange Friday. While initially, the price of oil made gains to threaten $73, crude oil eventually fell below $70 a barrel.

The price of crude oil fell $2.55 on the NYMEX Friday to settle at $69.29 a barrel and erase the gains made during the week's rally.

"Oil was rallying, once again, for reasons other than supply and demand," said Phil Flynn, vice president in charge of research for PFG Best in Chicago. "Earlier in the week, you had all this market momentum: The stock market was rallying every day; the dollar was getting slammed; and oil was rallying really reluctantly all week."

The price of oil has been propped up beyond what the underlying fundamentals can support by positive economic data that points to an end to the global recession and an increase in energy demand. Additionally, investors tend to buy oil as a hard asset and inflationary hedge when the value of the dollar drops.

"The question really was: Does oil deserve to be $72 a barrel when we're headed to the weakest period of the year?" Flynn continued. "We got a big boost with that surprise drawdown in crude supplies, but when you step back and look at inventories, we're still 11% above where we were a year ago for crude, the summer driving season is over, and supplies are above the five-year average. If we head into maintenance for heating oil season, we already have enough supplies to last us pretty much through the winter."

Oil Continues Trading Within Range

Crude oil has been range-bound for the last couple of months, trading between $65 and $75 a barrel. Despite numerous bullish rallies to break out of the range, the price remains pretty steadily range-bound.

"If the rally earlier in the week was not definitive, I don't think the sell-off at the end of the week was definitive," Flynn said. "We're still locked in a trading range."

While the price of oil is boosted by economic data, investing in the commodity has also been reined in by bearish supply and demand fundamentals.

"This market is trying to find an identity," Flynn explained. "Should it be rallying because the dollar is getting weaker, or should it be selling off because supplies are high and demand is weak?"

Where Is Oil Headed?

"Really what this week tells me is it's going to be harder and harder for oil to continue to drive higher without a lot of help," Flynn said. "They need a lot of help from the stock market, and they need a lot of help from a weak dollar; and if they don't get it, I think that this market is getting ready to fall back down."

While there are a number of factors that contribute to the price of oil, Flynn points to the economic stimulus in the US as a major reason for the high price of oil.

"I still think that we could see $50, even get into the $30s, by the end of the year," he predicted. "I still think that more and more, if the economy gets better, the topic of conversation is going to be an exit strategy from all of the stimulus that we've seen."

Should the US government slow or even pull the stimulus that the Fed has pumped into the economy, the price of oil is likely to fall.

"We know the stimulus cannot go on forever; there's going to be an end to it," Flynn continued. "Even though maybe we're not going to see the stimulus go away in the near term, I think over the long term we are going to see the stimulus go away, and the market is going to have to adjust to a world with less stimulus."

While the price of oil is being buoyed by economic optimism that the recession is waning, the mended economy will stop stimulus spending and dampen the price of oil.

"It's a double-edged sword," Flynn concluded. "If the economy gets better, we're going to use more oil and that should drive prices up. The bad news is when the economy gets better, we're going to remove the stimulus, which will put the dollar back up and bring the price of oil back down."

Natural Gas Falls After Strong Rally

The price of natural gas fell today in trading on the NYMEX after a huge rally that took the price above $3 for the first time since the October contract started. In trading Friday, natural gas fell nearly 30 cents to settle at $2.960.

Natural gas has been trading at seven-year lows for the past couple of weeks, beleaguered by overly bearish fundamentals. While a mild summer restrained domestic demand, the economic recession has bridled industrial demand for the commodity. Also, production has been unable to contain itself, with inventories reaching historic levels.

"Now that we've had this big run up, the question is: Is it going to be sustainable?" Flynn poses. "We're still going to end the refill season with a record storage number. Unless we see a big drop in production, or unless we see a very cold winter, supplies are more than likely going to be adequate."

The market is readying for the winter heating season, and some hope that demand will help to strike some of the over supply in the market. While the fundamentals remain bearish, investors' interest has been perked by the extremely low price of natural gas.

"I don't know if the bears have had their final say in the natural gas market, but it takes a lot more courage to be a bear after seeing that we're in September and we had that big pop up back above $3," Flynn concluded.