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Should we be bearish on oil?

By Investment Editor Adrian Ash Apr 28, 2006

Adrian Ash

Oil costing $73 per barrel and more 'may well create petrol prices above a pound a litre,' according to the chief of BP, Lord Browne. He spoke earlier this week as BP reported a drop in profits for the first 3 months of the year, down 4% to a mere £3bn.

Output of oil and gas dropped 1.7% over the same period. If you do the maths, you'll spot that the costs of producing energy are clearly rising.

The same plaintive cry has gone up from BHP Billiton. The world's largest mining stock says a 'shortage of people, equipment and supplies' is hurting the bottom line.

In short, the commodities boom is becoming a victim of its own success. Supply is so tight, bringing it on-stream grows more expensive by the day.

The commodities boom and crude oil prices: New sources of energy

'Today's [oil] shortages reflect the relatively low price prevailing through most of the 1990s,' writes Robert Cole in The Times. 'With so little price incentive, the industry switched its emphasis to consolidation rather than exploration or investment...That period left a shortage of rigs. Now everyone and his pet pig is frantically trying to seek out new sources of energy that will be available five or ten years hence. Long before that, consumers will react to cut demand.'

Hmmm...maybe. The entire commodities complex – along with the rush into steel and shipping – could come unstuck by 2008. Word in Aberdeen has it, for instance, that builders of heavy diesel engines for ships are offering two years delivery. 'They are that busy,' says Rodi – our unpaid correspondent in the Grampians.

'Shipyards now pick and choose which owner they will 'let in' to build with them...This rush for new tonnage of all sorts can only result in fleets of tied-up rusting hulks in two years time.'

The commodities boom and crude oil prices: The race to secure energy reserves

But maybe the cycle WILL be different this time?

Regular sufferers of The Reckoning know the case for 'peak oil' only too well. And with Russian monolith Gazprom given the all-clear by Tony Blair yesterday to bid for UK gas interests if it so wishes, the race to secure what remains of the world's energy reserves shows no signs of petering out yet.

Enough long-term guesswork, however. Right now 'the crude oil market is throwing off more mixed messages than a budding romance,' says our New York editor Eric Fry in a note today. 'Crude's alluring price profile seems to be saying, 'Come and get it'. But at the same time, this lovely creature seems to be whispering in our ears, 'I think it's time for you to go'...'

Such ambiguity rarely leads to a satisfying outcome...not in romance; and not in finance. Readers may be advised to steer clear of the oil market for a day or two. Crude oil has become one very hot commodity.

But where the hot money leads, investors seeking profit should fear to tread.

The commodities boom and crude oil prices: Speculator's pile into the market

'US crude oil inventories are a hefty 11% above the five-year average for this time of year,' Eric goes on. 'Natural gas inventories are also ample. Nevertheless, the price of crude continues to soar and the bullish speculators continue to pile into the market. Beware!'

Yes, according to the CFTC's Commitment of Traders report, the so-called 'large speculators' hold a record- high long position in crude oil. They held nearly 1,000,000 more bullish than bearish contracts at the end of last week. And who's been taking the other side of the trade? The 'commercial traders' just happen to hold a record-high net short position in crude oil.

'As you and your readers know,' says Eric, 'the 'Commercials' are considered the 'smart money' in the oil market. They have a tendency to position themselves correctly at important inflexion points. Their massive short position, therefore, bodes ill for the price of crude...and for all those speculators who are betting on it to go higher still.'

The commodities boom and crude oil prices: Bearish implications

What's more, the Marketvane survey of US commodity futures advisors validates the bearish implications of the Commitment of Traders report. According to the Marketvane, 76% of them are bullish on crude oil right now. This extreme reading is very close to the two-year high reading of 84%; it raises the likelihood that the overly popular crude oil market will become less popular very soon.

'All of these warning signs should inspire us to turn our back on this red-hot commodity,' concludes Eric. 'I'd suggest your UK readers look to do the same for a while. Go ahead and flirt with this 'hottie' if you must. But we'd hate to see you get hurt...'

This article first appeared on www.dailyreckoning.com

Published in Commodities | More articles by Adrian Ash

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