Oil Jumps Again, Natural Gas Follows

In trading Wednesday, the price of crude oil increased by more than $1.50 on the New York Mercantile Exchange. Closing above $72, the price was bolstered by a larger-than-expected draw in US crude inventories reported today from the EIA.

Following a more than $2 jump in prices yesterday, crude oil managed to tack on another $1.58 bump to settle at $72.51 a barrel on the NYMEX Wednesday. A positive economic outlook and a larger-than-expected draw in crude oil stockpiles helped to push the price of oil higher in trading today.

In its weekly report today, the US Department of Energy's EIA revealed an inventory draw of 4.7 million barrels of crude oil, which was much larger than had been expected.

"We ended up with a bigger draw than forecast and a decline in inventories directly in contradiction to the Tuesday night API numbers," said Bill O'Grady, the chief markets strategist at St. Louis-based Confluence Investment Management LLC, an investment advisory and management firm. "These two numbers can vary at times, but discrepancies like this are kind of a shock."

On the other hand, product inventories reported by the EIA were somewhat bearish for crude oil.

"Gasoline inventories were about as we expected; distillate was a little high; imports were down; consumption was weaker," O'Grady continued. "There was nothing in the report that was really supportive, except that drop in inventories, which was mostly a function of weaker imports for the second straight week."

Adding fuel to the rally, economic news released today helped to encourage investors in the crude oil market, following a statement yesterday from US Federal Reserve Chairman Bernanke that the recession was most probably over. Oil is seen as an attractive purchase because of hopes that the recession's end will boost energy demand.

"The second thing that helped the market, probably was a bigger factor, was the good economic numbers this morning that prompted a big lift in the stock market and weakness in the dollar," O'Grady explained. "These financial factors have been supportive for crude oil for some time now, and they were again today."

Furthermore, because of stimulus spending, many fear that the US dollar will become inflationary, and oil is being used as an inflationary hedge.

Oil Hits 'Sweet Spot'

Despite a near $3 jump in price in the last two days, crude oil remains in the trading range in which it has been for some time.

"We're doing what oil does a lot -- oil tends to be range-bound for long periods, and this one appears to be no different," O'Grady said. "We've been locked between this $65 to $75 range now for several months."

While the market has made several attempts to break out of the range, both on the upper and lower end, the price remains fixed.

"We're near the top end of that range, and it should have gone up on these really supportive numbers," O'Grady continued. "Frankly, I'm a little bit surprised we didn't see an even bigger lift, but all things considered, the market reacted positively to positive news, and that is what you would expect."

The combination of bullish news could have pushed the price of crude oil higher, but O'Grady contends that the commodity tends to stay affixed within its ranges, unless there is a surprise within the market. Additionally, he feels that the oil market has accepted the reality that the economic turnaround will not be quite as robust as others.

"Right now oil is at a sweet spot between $60 and $75 a barrel," O'Grady said.

Price VS. Stability

While the price of oil has regained some of its strength since the start of the year, the price remains substantially lower than where it peaked in mid-2008. O'Grady contends that while the price of oil is important, stability in the price is even more so.

"These aren't very attractive prices if you a producer; and they're not terribly attractive if you are an energy consumer, but the longer they stay here, the more you get used to it, the less of a problem it becomes," O'Grady explained. "One of the things I've noted in analyzing these markets over the years is that it's not just the level of the prices that matter, it's how fast it gets there; and the faster it gets there, the more unsettling it is."

OPEC has cut production to stabilize the price of oil, and many representatives within the cartel have confirmed that the current price point is comfortable for them. The oil cartel is making enough in profits, but are the publicly traded majors and independents doing so also?

"It's still profitable for them; it's just not as profitable as higher prices would be," O'Grady stated.

Many oil companies have slashed their budgets this year, and layoffs have been an unpleasant reality throughout the industry. O'Grady argues that it wasn't just the plummeting price of oil that caused these changes, but also the volatility in the market.

"The other factor that's involved in this that does get overlooked a lot is it's not just the level, it's the volatility as well," O'Grady said.

The 'Plight' of the Producer

As a producer looks at a more expensive project to develop, such as ultra-deepwater or shale, the company must consider not only the price of oil, but how much the price may vacillate.

O'Grady revealed that many of the major companies are excluded from OPEC projects or those in less-developed countries. Many times, the only projects that these companies can invest in are those that are more challenging, thus requiring a larger budget.

"Really that is the plight of the non-government-controlled oil company these days," O'Grady said. "They're basically stuck. If they want a reserve base they can control, they're going to have to do drilling in places that are hard. They have budgets to explore and try to drill, but the trick is that what they have to drill in requires pretty high prices, but also requires stable prices."

Unfortunately, O'Grady doesn't see price stability in the near future.

"The structure of the market is such that price stability is going to be very difficult to achieve," O'Grady revealed. "If anything, we're going to see increasingly volatile prices. There's really not much you can do about that; it's just a factor of the market."

Nonetheless, O'Grady sees this volatility as a reason why companies have been less willing to invest in more costly projects.

"They were very reticent to increase drilling budgets, even when prices were high because they just weren't convinced they were going to stay there, and in hindsight, they were exactly right," O'Grady added.

Natural Gas Makes Major Gains -- Again

The price of natural gas jumped again Wednesday on the NYMEX, settling at $3.76 per thousand cubic feet. Since Monday, the price of natural gas has made nearly a dollar in gains.

While some analysts point to short covering within the market as the reason for this rebound, others may hope for a bullish recovery.

Natural gas has been trading at seven-year lows on overly bearish fundamentals. Both domestic and industrial demand have been low, and the US inventory has reached record levels of the commodity. Furthermore, an inactive Atlantic hurricane season thus far has not threatened the Gulf Coast, and thus not prompted a short-term rally.

On the other hand, domestic demand may pick up with the winter heating season, although forecasts have called for mild temperatures.