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Position: We are long oil via the etf, USO

“There are known knowns. These are things we know that we know. There are known unknowns. That is to say, there are things that we know we don't know. But there are also unknown unknowns. There are things we don't know we don't know.” –Donald Rumsfeld

Oil opened down sharply this morning on the back of newly released projections for global oil demand from the International Energy Administration.  The IEA cut its world demand for oil by 1MM barrels a day, down to 84.5MM barrels, which is down 2.8% y-o-y.  The bulk of this decline comes from the OECD, which the IEA predicts will see a 760K barrel decline in demand y-o-y to the 45.2MM barrel level, which is down 4.9% from 2008.  The non-OECD, or emerging economies, are projected to use 38.3MM barrels per day, down 0.1% y-o-y.

Obviously, IEA projections should be considered a lagging indicator as the economic information that underscores their projections is well known.  That said, given the rapid rise in the price of oil over the last four weeks, and the positive increase year-to-date, the commodity is obviously vulnerable to bad news.

These newly revised projections from the IEA coincide with some recent negative data points in the U.S. relating to the oil market.  First, in its “This Week in Energy” update the Department of Energy stated:

“Consider just gasoline and distillate, which together represent over 70 percent of refinery output from crude oil. Energy Information Administration weekly data indicate that for the first quarter, demand for these two products fell more than 3 percent in total, (with gasoline declining 1.5 percent and distillate demand falling 6.7 percent). Distillate demand, which is mainly driven by heavy-duty trucking, has been hit hard by the slowing economy.”

In the same report, the DOE reported days supply nationally of petroleum products, and for the second week in a row it came in at 25.4 days, which was more inventory than expected and an increase of 14.9% y-o-y.  This inventory build is not surprising given the aforementioned decline in demand, but will be concerning if we do not see the drawdown in gasoline this summer in the driving season.

The data points above are coincident with a front page article on the Wall Street Journal today, entitled: “Oil Industry Braces for Drop in U.S. Thirst For Gasoline.”  The basic premise of the article is that demand for gasoline in the U.S. may have peaked due to a combination of more fuel efficient cars, increased use of ethanol based fuels, and less overall commuting by Americans.   In the article, Scott Nauman, Exxon’s head of energy forecasting, predicted that “U.S. fuel demand to keep cars, SUVs and pickups moving will shrink 22% between now and 2030.”  This is meaningful since “transportation” in the U.S. accounts for 2/3s of all oil use.

While the data points above are new, the question is whether they are actually incremental, or as Rumsfeld said, are these datapoints “known knowns.” The Oil market has shaken off negative fundamental data points consistently year-to-date and is now trading off the lows of the day despite the lowered expectations for global demand from IEA this morning.

Obviously, the question we must ask ourselves—to once again borrow from Rumsfeld—what are the unknown unknowns that may be currently sustaining oil prices well above prior lows? Is it massive money supply growth globally? Heightened geopolitical risk implications? The likelihood is that there are a number of drivers, most of which will only be known after the fact.

In the aforementioned Wall Street Journal article, China is also noted as a region of long term growth of oil demand.  Longer term, the Client (as we like to call China) may in fact be the dominant factor.  While headlines and articles about Chinese energy demand were rampant during the heady days of $140 per barrel oil, they are now largely non-existent, even though the long term demand implications from China have not changed. 

Currently, there are 250MM registered cars in the United States, which equates to cars per capita of ~0.83.  China may never get close to that number, but at a current population of ~1.3BN people and only ~57MM registered vehicles on the road, or 0.04 per capita, the Client obviously has a long run way of growing energy demand, in just the transportation segment.  Ultimately, as always, price rules.  As of now oil is largely looking past short term bearish data points and seems to be, once again, endorsing the longer term bullish case, even though this investment case is absent from the headlines.

Daryl G. Jones
Managing Director