The Oil Pit

When oil charged through $55 yesterday, your editor almost
lost an eye.

He was standing so close to the crude oil trading pit – on
the floor of the New York Mercantile Exchange – that an
airborne "Buy" ticket nearly grazed his cornea. The near-
miss left your editor with two good eyes, both of which
locked onto the tick-by-tick price action of crude oil, as
displayed on the massive electronic price board above the
pit.

In the span of a few minutes, the April contract jumped
more than $1.00 to $55.20 a barrel. Was this stunning
advance the start of an even bigger move, or the beginning
of the end of oil’s recent rally? We’ll examine the
question below…

The NYMEX is one of the few "open outcry" trading floors in
the United States. In other words, it is one of the
stereotypical commodity trading floors where arm-waving
brokers in jackets of various colors scream orders out
across a trading pit, while also gesturing incomprehensible
(to regular folks) hand-signals to one another.

The frenetic activity seems a quaint anachronism in this
era of electronic trading platforms. But some cumbersome
and bizarre practices – like lovemaking – persist, even
into the modern age.

Furthermore, the antiquity of the trading process does not
seem to present any impediment to rising prices. Somehow,
bull markets always find a way to manifest themselves, no
matter how outmoded the medium through which the
manifestation occurs.

Whether "price discovery" – as market gyrations are
euphemistically called – relies upon screaming traders or
ticker tapes or carrier pigeons, the collective opinion of
investors ALWAYS finds expression in the financial
markets…eventually. And the collective opinion of energy
investors is that oil deserves to command a price that is
higher than what it used to command a couple of years ago.

Yesterday afternoon, we watched in amazement as the
collective opinion of crude oil traders re-priced oil from
$53.05 a barrel to $55.20, before "discovering" that this
price might be too high, and marking crude down to $53.57
by the close of trading – good enough for a gain of 52
cents, but $1.63 off the day’s high.

Immediately, a bevy of experts began gaggling about the
"surprising" jump in crude oil prices and attempted to
provide some sort of explanation for the move.

"It’s the Iraq War that’s causing this," one veteran
commodity trader informed your New York editor.

"Really? The War?" he replied incredulously. "Aren’t simple
supply/demand dynamics a more reasonable explanation?"

"Yeah, that too," the trader admitted.

Another shell-shocked trader told the Associated Press,
"About the only way to explain this rally in the market is
fund buying. They’re pushing the market higher while
producing nations are sitting on their hands and smiling
ear to ear. This is incredible."

Several other crude oil experts credited OPEC’s Acting
Secretary-General for yesterday’s run-up in prices. Before
the start of trading, Adnan Shihab-Eldin candidly opined in
an interview with a Kuwaiti newspaper, "I can stress that
the probability that a barrel of crude rises to $80 in the
near future is a low probability. However, I can’t rule out
the rise of a barrel of oil to $80 in the coming two
years."

This modest speculation seemed to embolden the oil bulls,
while frightening many of the oil short-sellers into
covering their bets against crude. By the time the buying
had exhausted itself, the oil price had breached $55.00 a
barrel, or nearly as high as its record-high close last
October.

Admittedly, one’s days trading action does not possess a
great deal of significance. But crude oil has been rallying
for more than one day. Indeed, it has been rallying for
more than one year…or three years. We call this a bull
market. And bull markets generally occur for legitimate
reasons, at least in their infancies.

"Crude futures are up more than $10 since the year began,
reflecting concerns that the world’s petroleum supply is
being stretched thin by strong economic growth," the
Associated Press explains very rationally, "The weak dollar
and the apparent unwillingness of the Organization of
Petroleum Exporting Countries to pump more oil have
contributed to the latest run up in crude futures, which
are now 52 percent above year ago levels. However, analysts
and brokers say speculative buying by hedge funds and
others is magnifying the move higher."

Sounds reasonable to us. We have no idea, of course, where
the oil price might be heading tomorrow. But we may easily
observe that demand for the stuff shows little sign of
ebbing, especially in the country whose energy demands are
growing fastest. The chart below tracks the parallel paths
of China’s industrial production compared to its crude oil
consumption. The relationship and the trend are both pretty
clear. Rising industrial production begets rising oil
consumption.

China’s consumption, which soared comfortably above 6
million barrels a day in 2004, is likely to grow another
10% in 2005 to more than 7 million barrels a day, according
to PFC Energy, a Washington-based consultant.

But China is not the only industrializing economy that has
its hand out for a larger share of the constrained global
oil supply. Lawrence Goldstein, president of the Petroleum
Industry Research Foundation here in New York, suspects
that most energy analysts are underestimating the global
growth of petroleum demand, while overestimating the global
capacity to increase supplies of either crude oil or
refined products.

The $55 oil price suggests that the world’s oil producers
may already been having some slight difficulty serving the
world’s 84-million-barrel-a-day oil habit, not to mention
providing a supply-cushion in the event of an unexpected
disruption.

"Global oil demand has been growing at a very strong rate,"
Goldstein explains in a recent research paper, "and demand
will likely remain relatively strong during the next
several years. Interestingly, demand has continued to
surprise the markets and forecasts have steadily been
revised upward. Despite the sharp growth in demand, net
additions to global refining capacity have been
anemic…Additions to refining have been only about 15% of
the additions to demand."

The bears on oil hope – and maybe pray — that producers
and refiners will soon begin to sell heavily into the crude
market in order to lock-in future profits. Maybe so…Or
maybe these industrial short-sellers would merely be
locking in massive future loses.

$55 oil may seem like an "obvious" short sale to a world
accustomed to $35 oil. But what if $55 oil is actually a
counter-intuitive "long" to a world that might have to
adapt to $75 oil?

Did You Notice…?
By Eric J. Fry

While the NYMEX crude oil contract was busy flirting with
new highs yesterday, the contract for unleaded gasoline was
SETTING new record highs. The gasoline contract has jumped
a breathtaking 30 cents in the last three days to a record-
high $1.55 a gallon.

"This is especially bad news for consumers, given the fact
that gasoline prices have risen from early March to the
middle of May in 19 of the last 20 years," says energy
analyst Peter Beutel of Cameron Hanover Inc.

We would not argue with Mr. Beutel. But the nearby chart
suggests that this year might be one that makes an
exception to the rule. Wholesale gasoline prices are about
75% higher than they were one year ago, despite the fact
that gasoline inventories are 10% higher than they were one
year ago.

Or to look at unleaded’s price spike from another
perspective: The last time gasoline inventories were as
high as they are now (back in the spring of 2002), unleaded
gasoline sold for about 60 cents a gallon – NOT $1.55 a
gallon.

We would not dare to bet against the runaway unleaded
gasoline market, but neither would we be very eager to bet
on it.

[Ed. Note: Kevin Kerr advised his clients to sell their
unleaded gasoline call options yesterday, for a 17% gain,
saying the options were just too exposed to the immense
volatility in the energy sector, and had to go. This slim
gain is Kevin’s 17th consecutive winner! Congratulations
Resource Traders!

Last chance to grab the discount…

Resource Trader Alert
http://www.agora-inc.com/reports/RTA/WRTAF325

And the Markets…