Are Oil Fundamentals Justifying The Price Rise?

Fundamentals

Apparently not only stocks have caught a bid of late, as Crude Oil prices have been in bullish hands throughout much of the month of March. But do the current fundamentals really justify the $10-plus rally since the start of the month?

One consideration is that U.S. Oil stockpiles (excluding the SPR) are at their highest levels since the last week of June 2007 and approaching 16-year highs. World Oil consumption is expected to fall by 1.4 million barrels per day in 2009, according to the Energy Information Administration Short-term outlook released on March 10th . It appears that much of the gains in Oil futures can be tied to a renewed sense of optimism that an economic recovery may occur late in 2009, with the recent upswing in the equity markets helping to fuel this belief. The Fed announcement that it will embark on a policy of ” quantitative easing” helped to flame inflation fears and to propel near-term Oil futures past the $50/barrel mark.

In order to continue the rally, we will need to see hard evidence that both U.S. and world oil demand is actually improving. OPEC production cut-backs alone may not support $50-plus Oil prices, especially if demand continues to increase. In addition, it remains to be seen how long members of the Oil cartel will actually abide by their production quotas. The recent rally may entice a bit of “cheating” by members looking to offset some of the reduced revenue streams seen during the past several months.

Wednesday’s weekly release of U.S. Crude Inventories is expected to show a moderate increase of between 1 and 1.5 million barrels last week. A storage build much higher than the estimate could trigger a bout of selling by profit-takers, especially given the recent price run-up. Traders who believe Oil prices may be due for a bearish price correction can look to buy just out of the money puts outright in May Crude Oil futures.

However, these puts can be expensive, so a more conservative strategy would be buying a bearish put spread - such as buying the May 52 put and selling the May 47 puts.

As of this writing, the May 52 put could be bought for a premium of 3.25 ($3250), and the May 47 put could be sold for a premium of 1.38 ($1380). The total spread would cost about $1870, with a maximum gain of $3130 if May Crude Oil is at or below $47.00 by the option expiration on April 16th . The maximum loss is the premium paid.

Technicals

Looking at the daily chart for May Crude Oil, we notice prices accelerating to the upside once the May futures closed solidly above $50. A late session rally on Tuesday had buyers taking-out the recent highs of $54.05, despite a bit of a recovery in the U.S. Dollar. Since last Thursday’s sharp rise in volume, recent activity has waned, which may signal that new buyers are starting to balk at these price levels. Momentum as measured by the 14-day RSI remains strong, with a current reading of 61.25. The January 5th high at $56.17 has become the next resistance point for May Crude, with support seen at the $50.60 level.

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