Do The Fundamentals Justify $60 Oil?

Crude Oil futures have mimicked the equity markets lately, with the June futures rallying over $25 per barrel from the February lows. Though markets are generally forward-looking and there are some signs that an economic recovery may occur later in the year, do the current fundamentals justify the price surge? On the demand side, there are really no clear signs that Oil demand is increasing here in the U.S., with Oil stocks near 18 year highs. Worldwide, the Energy Information Agency (EIA) is forecasting world oil usage in 2009 down an additional 420,000 barrels per day (B/D) from its April forecast to 82.68 million B/D. OPEC has also lowered its forecast for Oil demand by an additional 200,000 B/D, with Oil demand now expected to fall by 1.6 million B/D in 2009. The supply situation is a bit friendlier, as OPEC has curtailed production in 2009, although “oil hawks” Iran and Venezuela have increased production in April.

Refinery rates in the U.S. continue to hover in the low 80% range, which can be viewed as bullish for “products” such as gasoline and diesel, but overall bearish for Oil, as lower refining production lowers the demand for Oil. There has been one notable buyer of Oil this year, and that is the U.S. Government, as current policy is to fill up the strategic petroleum reserve. Once this is completed, this will take another major buyer out of the market, which will decrease demand. There is talk that China may pick-up the load from the U.S. in its own pursuit to develop increased reserves as well.

A weaker U.S. Dollar is normally viewed as a bullish factor for commodities in general, and a good portion of the run-up in Oil prices may be tied to this factor and not specific fundamentals for Oil in particular. Just yesterday, in the weekly EIA energy stocks report, we had what appeared on the surface to be a very bullish inventory report for Crude Oil, with stocks falling by 4.7 million barrels last week, which is well below the 1.2 million barrel rise most analysts expected. However, what would normally cause a sharp run-up in Oil prices at $40 per barrel was not as well-received by traders, with Oil near $60 per barrel — especially with a larger than expected decline in refinery rates last week. This market action definitely gives merit to an old trading adage that “markets that will not rally on bullish news may no longer be bullish!”

Trade Ideas

Traders believing that the rally in Oil prices is due for a correction may wish to explore bear put spreads in Oil futures options. An example of this type of trade would be buying a July 59 put and selling a July 52 put. With the July Oil futures trading at 59.80, the spread could be purchased for approximately 230 points, or $2300, before commissions. The premium paid is the maximum loss on the trade, with a maximum profit of 700 points, or $7000, minus the premium paid, if July Oil is trading below $52 at expiration in June.

Technicals

Turning to the daily chart for July Crude, we notice prices hovering near their highest levels of 2009, with Oil bulls firmly in control for the past two weeks. Prices are now well above both the 20 and 100-day moving averages, and momentum, as shown by the 14-day RSI, remains strong with a current reading of 63.79. However, it appears that we are nearing overbought levels, and a moderate correction is not out of the question. The next resistance level for July Oil is seen near the $64.50 area, with support seen at the 20-day moving average near the 54.90 area.

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