Why Oil Prices That “Should” Be Going Higher Are Going Lower

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By Dan Dicker, Inside Investor, via Oil & Energy Insider, a premium publication that gives subscribers an information advantage when investing, trading, or doing business in the energy sectors.

The world has changed.  Even two years ago, with a war going on by proxy between Russia and Ukraine, we’d have seen a $10 rally in the price of crude, not prices below $97, like we’re seeing today.  Add to that the Iraq crisis in the North, the continuing Syrian conflict, the destabilization in the oil-producing countries of Libya and Egypt and you’d have been shocked – at least in 2011 – to see prices go decisively under $100 a barrel and act badly there.  What’s going on here?

One long-term trend in the oil market and one very short-term trend have made the difference between a price that ‘should’ be higher, but is in fact going lower.  We need to really understand those changes to track where oil prices will go next and where those underlying oil stocks are headed.

Let’s take the long-term trend first.  For the years from 2003 until just about a year ago, the oil markets were dominated by trade that was mediated by the big investment banks, particularly Morgan Stanley, Goldman Sachs and JP Morgan.  Those banks, besides having their own proprietary capital in the forwards and futures markets, also developed an army of participants on both sides of the trade, both commercial players looking for risk management of oil and speculative players, in the form of passive investment and new commodity based hedge funds.

But the banks, and particularly these largest three, have abandoned the oil market, selling their proprietary interests or outright closing them down – which had an on the nature of the trade – and abandoning the sales of futures components on a commercial and retail level.  This has taken an enormous amount of speculative steam out of the oil trade, leaving most of the volume to private physical traders, algorithms, and dedicated hedge managers.

In effect, many of the new speculative interests that would flood the markets with every geopolitical change are now gone. You won’t find a massive inflow of new money when the latest dust-up in the Middle East occurs, as it did for the Iranian threats in the Gulf of Hormuz or the Libyan Civil war even a few short years ago.  The banks were mostly responsible for herding these kinds of new money interests. And now they’re mostly gone.

The short-term trend? Everyone is currently long.  Virtually every dedicated hedge fund and physical player – the remaining big money traders – are expecting the geopolitical risks to global oil translate to higher prices, and rightly so.  But their positions are one-way and practically unshakable.  You can see that in the latest Commitment of Traders report from the CFTC, where speculative shorts in crude oil have fallen to a historic low of 3%.

Despite the real risks to global supply and the very likely prospect of a true crude shortage in the near-future, you still cannot get prices to go higher when everyone has the trade on the exact same way.  In the end, as with all financial markets and no matter what the fundamentals say – if you don’t have more buyers than sellers, or in this case, if all the buying is already done with little more on the way – there’s only one way for the market to go, and that’s down.

What can change this?  Well, we can’t expect a new agent of retail and commercial sales, like the banks to emerge, that’s for sure.  What will have to happen is either a shake-out of the longs already in the market – a possibility should crude cross the long-term trend line at around $94 – or the influx of new buyers.  Those new buyers will need to be inspired by a new trade, involving the dollar perhaps, or another, even worse geopolitical event, or a true physical shortage of supply.

But until one of those things begins to happen, expect this slow swoon of oil prices to continue – despite all the fundamentals that strongly point to the contrary. By Dan Dicker, Inside Investor, via Oil & Energy Insider

And here’s another reason for the drop in the price of oil: demand in the OECD countries shrank in Q2. But the real surprise is slow demand growth in China, where the economy is cooling. Read….. As Global Demand For Oil Drops, Worries Rise for Debt-Heavy Oil Companies

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  5 comments for “Why Oil Prices That “Should” Be Going Higher Are Going Lower

  1. Aug 16, 2014 at 5:45 am

    Oil prices are in for a world of hurt. Not sure when, but it won’t be pretty. The good news is gas will be cheap again!

    Natural Gas, on the other hand will just get more expensive.

  2. john
    Aug 16, 2014 at 9:12 am

    Excellent collection.

  3. Petunia
    Aug 16, 2014 at 12:05 pm

    I live in the Sunshine state where you have to do battle with local govts to put solar panels on your house. It is generally not allowed. It should be mandatory on all new construction to use some solar power. Solar should be mandatory everywhere in the sun belt.

    Gas prices are down and people are still not driving as much. No money.

  4. Aug 16, 2014 at 1:41 pm

    “We never saw it coming,” can be the phrase that defines out particular post-industrial time period. Analysts are surprised, and why not, they are all part of the truthiness brigade … the absolute believers in self-driven, self-modulating industrial ‘growth’ which is really industrial suicide-by-inches. (By 90 million barrels per day paid for with borrowed ‘money’ … )

    The reason oil prices are falling is because the (marginal) oil customer is dead broke, he can borrow no more. He’s paid out his childrens’ and his grandchildrens’ incomes so he can drive a useless, non-remunerative automobile in circles from gas station to gas station … multiplied times one billion. At the same time, the petroleum extractors costs ratchet upwards relentlessly, soon to be out of reach of the extractors’ ability to borrow …

    This is the reason for ZIRP, it’s an indirect subsidy for the petroleum industry.

    Face facts, dudes, we’re all in big trouble right now. Broke customers + rising petroleum costs = shortages. Keep in mind, when fuel shortages are caused by inability to afford the fuel, they (shortages) are permanent (less fuel does not cause consumers to become wealthier or more credit worthy … )

  5. mike@apartmentsapart.com
    Aug 17, 2014 at 12:56 pm

    It’s also worth noting that low oil prices are in the interest of the west. Not only are they needed to keep GDP rolling along, a low oil price will also put pressure on Russia, which is top priority just now.

    I have no idea if it’s even possible to manipulate such a huge market, but it doesn’t mean they will not try,

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