Oil: Solidly In Contango...

Bearish short term, but longer term production issues are likely…

Keith mentioned in the morning meeting today that he thinks Oil looks broken technically. Our range for buying and selling Oil (using West Texas Intermediate per barrel as a proxy) are sell levels at $72.10 and buy levels at $60.82, which is a wide and very tradable range. This bearish technical view also coincides with a bearish futures market, which, as outlined in the chart below, is solidly in contango as futures prices are much higher than the near month contract.

In a contango scenario, inventories should be driven up for refiners and producers as they hold the commodity since it is worth more in the future. Obviously this is indicative of weak short term demand. The most recent data from Master Card confirms this as motorists consumed 6.4% less gas in the past week compared to a year ago, so even though gasoline is back in the mid $2.50 per gallon range demand is still anemic.

While we have a bearish short term view on Oil based on declining demand, the longer term production issues remain and will likely only be amplified when global growth again accelerates. The implications of the credit crunch and recession are that investment in Oil exploration is slowing and will continue to slow, which eventually will eventually lead to a supply driven rally in oil.

The Executive Director of the International Energy Agency Nobuo Tanaka stated on October 28th that “the financial crisis may delay oil projects and lead to serious supply crunch.” The IEA will likely reflect this expectation of lower investment, and increased potential for production issues, when they release their annual energy outlook in London on November 12th.

Daryl G. Jones
Managing Director

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