Back in July I was surprised to notice that oil prices continued to remain firm during the odd 2011 summer months (an anomaly caused by strife in the Middle East) when ordinarily we experience softness in energy prices that time of year. In fact I was concerned it would (and to some extent it did) derail the U.S. economic recovery that was slowly underway:
Another stumbling block (to economic recovery) has been energy prices. I’m coming to the conclusion that although the price of oil may decline modestly from current levels – based on my ‘friggin-ridiculous-expense-to-fill-the-bloody-tank-on-my-Harley’ proprietary indicator; for the most part I don’t see a major collapse in oil pricing given these emerging big picture fundamentals. (from my commentary entitled China, Commodities, Oil – buy when bad is bad and good is bad! Posted on July 20, 2011)
My refusing to fill up my Harley’s gas tank as often must have had the desired impact, the oil price fell even more than I expected from around $100 a barrel to south of $80. As you can see from the following chart, there is a seasonal pattern to the rise and fall of total U.S. crude inventories. A visual scan of the rollercoaster pattern might inspire one to conclude that it’s about that time of year again for a buildup in oil inventories – but what would this mean for oil prices and of course the stock prices of energy companies?
The idea that there might be a ‘natural’ oil price has occured on many occasions over the years, only to ruin the career of many an energy industry analyst. Inflation, discrepencies in global economic development, war and oligopolies – all these seem to have a varying influence over time on the oil price range. However for very short periods, it seems there is seasonality at play. Whether the starting point (or “new range”) begins at $40, $80 or $100, most of the time the price of oil declines early in the year (December, January, February) and just before March the price usually begins a rather aggressive climb until April or May of the year. Take a look at the below chart.
Oddly enough, it appears that the price of oil rises in tandem with building inventories. At first, this phenomenon seems counter-intuitive to me.
But as liquid an asset as crude oil is (ha ha) I suppose that it is quite reasonable to find that as it’s price is rising, both those who speculate on the price (hedge funds, commodity traders) and those who actually need oil (gas stations and industry) would prefer to get as much of the black gold into inventories as possible before it gets even more expensive, causing a good deal of hoarding.
It’s hard to believe the price of crude was $80 just a few months ago (September), then popped to $100 at yearend and has rolled over to a few dollars less than that today. Based on this seasonal pattern, we might very well see it bottom at $90 or less in February/March but I don’t believe we’re likely to see it as low as $80.
Why? As I’ve mentioned in several commentaries, it’s the U.S. that leads the global economy into or out of recessions. Europe and Asia followed the U.S. down, and they will lag the U.S. recovery which began (with stumbles) way back in 2010. It’s true that China consumes an increasing amount of the world’s oil, but it’s the growing strength in the United States which will drive prices higher. The U.S. is hands down the largest consumer of liquid fuels on the planet.
A good number of the energy company stock prices are already discounting an improving oil price scenario. It is possible that in some cases the optimism is several weeks too early. The spot market in the very short term can be distorted significantly by temporary imbalances. Despite rising demand in the U.S., European consumption especially surprised industry analysts with substantially lower demand at the end of last year – not all that surprising in retrospect given the financial turmoil over there. Quite possibly the fallout from that turnoil has not run its course (Greece) and might drive spot prices down over the next few weeks.
So we can buy the stocks knowing there’s a risk of very short term downside volatility, or alternatively we can look to buy the laggarts which haven’t yet moved. The graph illustrates my point. Although Suncor has enjoyed a lift, Talisman remains in the doldrums. Because TLM has a higher ‘natural gas’ component to its production profile, and natural gas pricing is sloppy indeed, the stock remains in the dumps. But a substantial 45% of their production is still oil and therefore sensitive to any improvement in crude oil pricing.
I mentioned we could expect to see the oil price run up to $120 by April/May of this year. Why’d I pick that number? I got the idea from this quote dating from back in 2008:
ScienceDaily (May 21, 2008) — With the price of a barrel of oil hovering around $120, U.S. drivers can expect to pay more at the pump in the near future, according to a new study by Rice University’s Baker Institute for Public Policy.
Frequent readers of this blog (or my book) will know that headlines are often the best (contrarian) indicators. We know that shortly after the scientists made the above prediction, oil prices collapsed to the $40 level. They didn’t see the recession coming. and hadn’t caught on to the ‘seasonality phenomenon’ old timers like me are used to. Well, I figure right now that most market observers aren’t aware of the boom that’s early days but demonstrably underway in the U.S. economy, and are oblivious to seasonal strength in the springtime. After all, I haven’t seen any predictions in the press for higher oil prices at all. A forecast of $120 is as good a number as any……so long as the direction is UP the energy company stocks should do well.