Crude Oil To Remain Depressed

Yesterday, crude oil futures settled below $75 per barrel, hitting a three month low.  Although the U.S. Energy Information Administration (EIA) recently raised its forecasts on oil prices, supply and demand forces suggest otherwise and point that these price levels will remain intact, if not witness a further decline.

On the demand side, demand in the US and other major oil consuming nations is expected to remain sluggish as governments try to bolster economies and some attempt to cut deficits.  In fact, the International Energy Agency (IEA), estimates that world oil demand will average 86.4 million barrels a day, 220,000 barrels fewer than forecasted in the previous month.  One reason behind this revised forecast is weaker than expected consumption in some parts of Asia and a worsening economic situation in parts of the Middle East.  This revision was also driven by changes to historical demand data for 2008 which are reflected in the total 2009 and 2010 consumption estimates.

On the supply side, US crude-oil stockpiles are at their highest levels since December.  In fact, inventories at Cushing have risen for eight weeks in a row, pushing the amount of oil in storage at the hub 29 percent higher than levels seen a year ago. 

A second force that will likely put supply pressures on crude in an increase in production by non-OPEC producers, which account for nearly 60 percent of the world’s supplies.  According to the IEA, output is expected to increase by 800,000 barrels per day, to an average of 52.3 million barrels a day.  

Lastly, supply pressures are likely to be brought on by OPEC.  In April, the 12 member oil cartel increased production by 40,000 barrels a day.  In conclusion, as long as the world’s thirst for oil remains in check and supply remains high, this imbalance is likely to keep crude prices relatively tame.

Some equities that are likely to be influenced by the price of black gold include:

  • The US Oil Fund (USO), which holds futures contracts in crude oil.  USO closed at $36.13 on Thursday.
  • The iShares Dow Jones US Oil & Gas Exploration (IEO), which focuses on upstream oil companies like Occidental Petroleum (OXY) and Apache Corp (APA).  IEO closed at $54.42 on Thursday.
  • Oil Service HOLDRs (OIH), which focuses on oil services companies which have been feeling the wrath of the recent oil spill in the Gulf of Mexico.  Its holdings include Transocean Inc (RIG) and Schlumberger Inc (SLB).  OIH closed at $113.98 on Thursday.
  • iShares Dow Jones US Energy (IYE), which is a diversified play on oil and includes exposure to fully integrated oil companies like Exxon Mobil (XOM) and Chevron Corp (CVX), as well as upstream companies like Occidental Petroleum and oil services companies like Schlumberger.  IYE closed at $33.06 on Thursday.

When investing in these oil driven equities, it is equally important to consider their volatility and inherent risks.  To help mitigate these risks, the use of an exit strategy is important. 

According to the latest data at www.SmartStops.net, an upward trend in the mentioned ETFs could come to an end at the following price points: USO at $35.74; IEO at $51.82; OIH at $108.65; IYE at $31.76.  These price points change on a daily basis as market conditions fluctuate and are reflective of market volatility.  Updated data can be found at www.SmartStops.net

Disclosure: No Positions

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