Position: Long Oil via the etf USO
In the last nine weeks, we have seen a bifurcation in the price of oil and copper. While the correlation is still high, oil has outperformed Dr. Copper. Specifically, copper is down 8% over the last nine weeks, while oil is up 1%. Prices matter.
As we have often said, Dr. Copper received her PH.D in economics for her work as a leading indicator. As Keith mentioned in the Early Look today, Dr. Copper seems to be signaling that global growth may be set to moderate. This, of course, isn’t surprising given the steps that China has taken to slow loan growth and property construction. In a tight note yesterday, Darius Dale highlighted a few of these points, the most important of which are:
- China's Banking Regulatory Commission ordered 78 state-controlled companies to exit real estate sector;
- Chinese Banks are now asking for 40%-50% down payments for second mortgages;
- In March, Chinese officials raised deposit requirements for buyers at land auctions to 20% of the minimum price to increase costs for developers; and
- China's State Council raised down payment requirements for second homes to at least 50% and have pegged mortgage rates to no lower than 110% of the benchmark rate.
This headwind is obviously bearish for the price of Dr. Copper, since China consumes roughly 1/3 of the world’s copper, a large part of which goes into construction.
In contrast, oil has a more favorable set up. We bought oil earlier this morning in the Virtual Portfolio as it neared its TAIL Line. Two bullish points that we want to highlight on oil this morning relate to geo-political risk and drilling activity in the Gulf of Mexico.
We do not have the intention of being alarmists, but if the event in Times Square reminds us of anything, it is that terrorism is alive and well. While the car bomb has been described as “amateurish”, the fact remains that the perpetrator was able to drive and park a car bomb in Times Square. Given the amount of news in the news cycle in recent days relating to Goldman Sachs and sovereign debt issues, the brazen nature of this attempted attack was left somewhat unanalyzed. The reality is, even if there were merely a hundred such individuals in the United States, they could do serious damage. The ultimate derivative of such attacks is that the United States accelerates military action in the Middle East, which puts at risk global oil supply, at least in the short term.
Over time, despite assurances from each respective President that this would not occur, the United States has become increasingly dependent on foreign sources of oil. In the table below, we’ve outlined the U.S.’s increasing dependence on foreign oil over time, which, in aggregate, emphasize the increased geopolitical risk factor that should be incorporated into the price of oil.
The other important point to emphasize, which is bullish for oil, is the oil spill in the Gulf of Mexico. The oil spill is quickly becoming the most substantial potential environmental disaster in decades in the United States. For comparison purposes, the Exxon Valdex spill was 11 million gallons, but in this situation, a well is leaking, which has many times the capacity of a tanker.
We are already seeing the impact of this spill from a policy perspective. Specifically, Governor Schwarzenegger from California has withdrawn his support for expanded drilling off the coast of California. In the worst case scenario, offshore drilling in the United States is dramatically curtailed, or halted outright. In a more realistic scenario, costs for offshore drilling from insurance and increased infrastructure increase dramatically. Regardless, the nominal cost of drilling offshore in the United States will go up, and supply will tighten on the margin.
In the shorter term, the oil slick could disrupt production in the Gulf. The key offloading port for oil in the United States is Louisianan Offshore Oil Port, which is where many foreign tankers offload their oil. If the slick gravitates towards that area, it could halt 300K barrels of daily oil production and 1.3 billion cubic feet of natural gas product, which is equivalent to a major hurricane shut in. The slick would obviously slow the offloading of tankers as well.
We are buyers of oil this morning as it trades down towards it’s long term TAIL line.
Daryl G. Jones