Will Oil Reach New Low by the End of 2012

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The price of oil zigzagged in the last few days on account of the high uncertainty in the markets with respect the U.S Presidential elections. Now that the elections are over, oil traders can focus on the fundamental changes in the oil market and the potential ramifications to the U.S economy under the incumbent President Obama in the next four years. Let’s examine the recent developments in the oil market, review the potential effect of the changes in the price of oil on oil companies, and figure whether the price of oil could further decline during the rest of year.

During November (up to date), the price of oil declined by 2.1%; United States Oil (NYSEMKT: USO), by 1.8%. Despite the recent fall in the price of oil, it has still increased by a larger margin than other assets have during the year. In the chart below are the normalized (as of January, 3) prices of natural gas, oil and the S&P500 index.

<img src="/media/images/user_12845/snp500-oil-and-natural-gas-november_large.jpg" />

On a quarterly basis, the price of oil declined in the past couple of quarters. This fall had different effects on the major oil companies. The chart below presents the operating profitability of leading oil companies against the quarterly oil price. 

<img src="/media/images/user_12845/exxon-chevron-and-royal-profitability_large.jpg" />

During the third quarter the operating profitability of ExxonMobil Corporation (NYSE: XOM) and Chevron Corporation (NYSE: CVX) declined. On the other hand, the operating profitability of Royal Dutch Shell rose during the recent quarter compared to the second quarter.  This analysis is of course very crude and doesn’t consider the changes in each company’s operations; nonetheless it does show that at face value the price of oil didn’t seem to have a strong effect on these companies’ profit margins. Let’s examine what has changes in the fundamentals in the oil market.

Storage

Last week, the U.S. Petroleum and oil stockpiles rose by 0.7 million barrels; it reached 1,793 million barrels. The current oil stockpiles are 48.6 million barrels above the levels during the same last year. The current high level of oil suggests the oil market is looser this year compared to last year. Moreover if this stock build up will continue, which I suspect it will, this could further loosen the oil market. The linear correlation between the changes in stockpiles and oil prices is mid-strong and negative, which mean that if oil stockpiles will further rise, it could suggest that oil prices aren't likely to rally.

Supply

From the supply side, according the recent EIA report, the U.S oil production continues to increase, as the average production rose last week by 0.3% (week over week) and by 13.4% compared to the same week last year. Refinery inputs edged down by 0.1% but remained 1.8% higher than last year.  If the U.S supply will continue to expand in the weeks to follow it could further pull down the price of oil during the rest of the year.  The chart below presents the recent shifts in the four week average oil production and the weekly average rate of oil during 2011-2012. The recent rise in the oil production coincided with the tumble in oil prices.  

<img src="/media/images/user_12845/four-week-average-oil-production-million-bld-weekly-oil-price-2011-2012_1_large.jpg" />

From the supply and storage side it seems the oil market is loosening up in the U.S which should pressure down the price of oil. The EIA in its recent report predicts retail gasoline prices will fall in the coming weeks on account of its projected decline in crude oil prices (among other reasons). Nonetheless there are some concerns from the supply side that could curb the price of oil from further falling:

  1. Hurricanes and Storms:  Hurricane Sandy might be over but its adverse ramifications on the oil market may keep oil prices from falling in the near future. During last week two refineries in the New York Harbor area weren’t operating. It’s still not clear the damages of that hurricane on the East Coast infrastructure. But in any case such events are likely to keep the uncertainty in the oil market.  The new storm  to the Northeast region also poses uncertainty around its effect on oil. As long as the Hurricane season is still in progress the price of oil could resume short term rallies.
  2. Political Instability in the Middle East: There are still concerns in regards to the tensions in the Middle East and the tensions between Iran and the U.S. Under President Obama many think he has a better chance to resolve the current tension with Iran without military action. Since Israel is heading towards elections in the beginning of 2013, it is less likely that there will be an escalation in the Middle East at least after the elections. In the meantime, this situation is likely to keep the price of oil from tumbling down.

From the demand side there are some signs of slow recovery in the U.S: the number of jobs added in October was higher than many had expected, manufacturing is expanding and the U.S GDP rose by 2% during the third quarter, which is higher than the previous quarter. These reports suggest there is some progress in the U.S economy which could lead to a rise in demand for oil. Conversely, the concerns over the "fiscal cliff" could also lead to a rise in uncertainty, which, in turn, could affect commodities prices.

The bottom line

I think the recent developments from the supply side could further pull down the price of oil in the months to follow to reach the low 80s and perhaps even the high 70s. On the other hand, the uncertainty around the ramifications of Hurricane season, the stability in the Middle East and the modest signs of slow recovery in the U.S are likely to keep the price of oil from tumbling well below the above-mentioned base lines.

This analysis on oil prices was first published on Trading NRG

For further reading:

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Why Caterpillar isn’t pulling up? Just Blame it on the Oil

 



liorc has no positions in the stocks mentioned above. The Motley Fool owns shares of ExxonMobil. Motley Fool newsletter services recommend Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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