As bull markets go, crude oil’s run looks nearly perfect. Higher highs, and higher lows have dispensed a price history in recent years of unusual clarity. A more perfect scenario for a bull could hardly be imagined.
As you can see from the chart below (courtesy of the Energy Information Administration, as are all subsequent charts posted), the last two years of oil pricing have been a model of bullish behavior from a technical analyst’s perspective. Every time a selloff arrived, it was but a temporary setback to even greater heights. Going long oil, in short, has so far been one of the great trades of the 21st century.
That, of course, is obvious to even a casual observer. What comes next, by contrast, remains the stuff of speculation. In an effort to make it informed speculation, we present the following analysis, starting with some macro context, which entails our belief that in the long run higher prices are likely to prevail. That outlook comes courtesy of the consequences that invariably spring from what we see as tightening supplies and rising demand.
The three variables that could upset our bullish forecast in the long run are geopolitical risks, an unexpected surge in global economic growth, and technology. The latter is the only one that’s assured.
Technology, in one form or another, will intervene by delivering greater-than-expected supply. Make no mistake: everything from alternative fuels to improved means of extracting oil from the ground to enhanced efficiency in consumption will boost supply. Whether the associated supply is boosted to a degree that makes a material long-term impact on the global supply/demand equation is the question. Based on the data we’ve seen, our guess is a cautious “no.” At best, the ability for technology to offset the realities of a maturing supply future in conventional oil is a huge guess. At worst, it falls far short of expectations in keeping a supply crunch at bay. As such, short of some extraordinary breakthrough that at present remains unknown, bullish forecasts for oil prices in the years and decades ahead seem eminently prudent.
It’s all about Economics 101 in the oil game–in the long run. In the more immediate future, predictions become more unstable, and the primary contributor to this instability at the moment is the global economy, and the United States in particular.
Because the U.S. is by far the world’s largest consumer of crude oil, changes in America’s economic rate of growth will have more than a trivial impact on the price of oil. When and if the economy stumbles, something more than a temporary correction in oil market may arrive. Timing, of course, is the great question that can’t be answered. But we can monitor the facts as they arrive, and draw some conclusions.
With that in mind, there may be clues about the future direction of oil prices embedded in the trend of U.S. oil supplies. As the chart below reveals, supplies (or stocks, as they’re called in the trade) have been moving higher in relative and absolute terms. The oil companies serving the domestic market have been loading up on crude stocks in anticipation that demand will continue rising at a pace that’s at least consistent with the recent past.
Perhaps, although as the next chart shows, demand for gasoline (the primary byproduct of crude oil) is showing signs of leveling off for the moment, which may be a prelude to price declines, albeit temporary.
Indeed, it’s worth noting that operating capacity at U.S. refineries has recently been running significantly below the year-earlier rate. For the week ended this past May 19, for instance, refinery capacity utilization was running at 89.6%, significantly below the 93% rate in the same period from 2005, according to the Energy Information Administration.
Deciding if this all adds up to a long-lasting correction in the price of oil will likely turn on marginal changes in the rate of economic growth. Definitive conclusions, alas, arrive only with the benefit of hindsight. But with a growing number of economists predicting a slowdown in GDP’s pace for the second half of this year, it’s time to consider the implications for the price of oil.
The Energy Information Administration is doing no less. In a May 9 forecast of oil prices for next year, EIA’s calls for an average price that remains more or less unchanged from this year. For the price of a commodity that’s shown an inclination to materially rise in recent years, even when measured by the slow-moving average annual price, the EIA’s latest outlook may be a sign of things to come.