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Position: Short etf USO (United States Oil Fund)

Yesterday in our morning meeting that we host for clients, we had an interesting debate regarding some of the global macro signals that we are seeing these days relating to oil.  We seem to be clearly seeing signs of heightened global tensions with the Iranians announcing that they have a second facility for converting uranium and are also testing longer range missiles this week.  Despite these events, the price of oil has completely shrugged off any longer term implications from Iranian chain rattling.  This is partially due to the strength in the U.S. dollar, as the U.S. dollar has been one of the key fundamental drivers for oil prices this year.

Setting aside the U.S. dollar, over time supply and demand metrics in the world’s largest oil markets, the domestic United States and China, should also be key drivers for the price of oil.  As we’ve noted a number of times in the last few months, oil fundamentals are actually quite bearish. The most recent date from API, the EIA, and China are bearish as outlined below:

  • According to the most recent date from API, gasoline inventories in the United States are 12.6% higher than a year ago and 5.6% higher than the five year average;
  • According to most recent date from EIA, oil inventories are more than 10% above year ago levels (at 335MM bbls) and gasoline inventories are 19.7% above year ago levels; and
  • The Chinese reported today that crude oil inventories hit a record 39.9 million tonnes at the end of August, which equates to a rather significant 278MM barrels.

Despite the bearish date, the price for oil, as we’ve discussed, has had an incredible move this year and as a result we are starting to see an uptick in drilling activity for oil, which is also bearish as it relates to future supply. To this point, the EIA noted last week that:

“As of September 18, Baker Hughes Incorporated reports 293 rigs drilling for oil and 705 rigs drilling for natural gas. The current oil rig count reflects a 64 percent increase from the lowest 2009 level reached in early-June, while the natural gas rig count is only 6 percent above its mid-July level (Figure 1). Rigs drilling for oil now account for 29 percent of the total, up from 21 percent at the beginning of the year. Despite the uptick in oil drilling, both oil and natural gas rig counts remain substantially below their peak levels in 2008.”

Interestingly, for the first time in nine years, we have also seen oil drilling activity surpass natural gas on a relative basis in the domestic U.S. and is up an amazing 64% from its lows.

As Keith noted in The Early Look this morning, we’ve also had three separate statements from Fed Governors recently suggesting that rates will have to go higher.  That is, they’re starting to get hawkish.  In the short term, higher rates should be positive for the U.S. dollar, which will be, all else equal, bearish for those commodities that are priced in U.S. dollars.  So, we are shorting oil today because: a) supply is building, b) the likelihood of a rate hike has increased, which is good for the dollar and bad for commodities priced in the dollar, and c) oil is largely shrugging off heightened geo-political news flow.

Daryl G. Jones

Managing Director

We Are Short Of Oil - a2