Will Crude Oil Change Direction and Fall?

Lior is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

During November, the price of oil has only slightly rose despite its high volatility. The recent tensions in the Middle East may have contributed to the rise in volatility in oil prices. Will oil prices continue to rise in the weeks to follow or will it come down to the low 80s? Let’s examine the recent changes in the oil market, review how the price of oil may have affected oil companies, and try and figure what’s next for oil in the weeks to come.

During last month, the price of oil rose by 3.1%; United States Oil (NYSEMKT: USO), by 2.5%. Despite the recent rally in the price of oil, it has underperformed other assets during the year. In comparison, in the chart below are the normalized (as of Jan. 3) prices of natural gas, oil and S&P500 index.

<img src="/media/images/user_12845/snp500-oil-and-natural-gas-december_1_large.jpg" />

During recent months, however, the price of oil has declined. This fall could adversely affect the revenues of major oil companies and also their operating profitability during the fourth quarter. In the chart below is the operating profitability of leading oil companies against the quarterly oil price (including the average price of oil for the fourth quarter of 2012).   

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

As seen above, the moderate fall in the price of oil from the second quarter to the third quarter may have contributed to the drop in the operating profitability of ExxonMobil (NYSE: XOM) and Chevron (NYSE: CVX). On the other hand, the operating profitability of Royal Dutch Shell (NYSE: RDS-A) increased. The current average price of oil for the fourth quarter is only $88.3, which is 4% below the average price in the previous quarter and 6% below the price during the fourth quarter in 2011. Thus, if the price of oil will continue to dwindle in December, this could adversely affect the operating profitability of these oil companies.

So let’s examine the recent fundamental changes in the oil market.


During last month, the U.S. Petroleum and oil stockpiles declined by 11.6 million barrels; it reached 1,781 million barrels. The current oil stockpiles are 41.1 million barrels above the storage during the same week in 2011. Despite the recent fall in storage, the relatively high storage (compared to last year) suggests the oil market is slightly looser this year compared to the previous year. Nonetheless, the recent fall in stockpiles could pressure up the price of oil in the U.S. The linear correlation between the developments in stockpiles and oil prices is mid-strong and negative, which suggests if oil stockpiles will continue to dwindle, it could pull up oil prices.


From the supply side, according the latest EIA report, the U.S oil production increased, as the average production rose during November by 1.6% (week over week) and by 14.6% compared to last year. Refinery inputs edged up by 0.2% and were also 1.7% higher than last year. On the other hand, Imports sharply declined by 4.6% during November. The drop in imports could have contributed to the rise in oil prices during the month. Hurricane Sandy contributed to the drop in shipment of oil to the Northeast Area.

The chart below presents the developments in oil imports and the changes in oil prices on a weekly basis during 2012. As seen, the fall in oil imports during recent months coincided with the fall in oil prices.

<img src="/media/images/user_12845/four-week-oil-imports-oil-price-2011-2012_large.jpg" />

Once the shipments of oil will return to normal this could raise the supply of oil and thus bring down oil prices.

According to the latest OPEC report, OPEC’s oil production remained stable as of October. Moreover, according to the IEA, non-OPEC production rose during October.  This means the supply in OPEC and non-OPEC countries is stable and shouldn’t pressure up oil prices.

From the demand side, the U.S economy is showing mixed signals as to it progress: according to the recent GDP update, U.S GDP expanded by 2.7% (annual growth) in the third quarter. Conversely, manufacturing PMI fell below the 50 point mark, which means the manufacturing sectors in the U.S are contracting. Moreover, the Philly fed index also tumbled down according to its latest survey. This mixed signal could have raised the uncertainty in the oil market. If the upcoming U.S reports will show little signs of progress they could suggest a low growth in the U.S demand for oil, which, in turn could lead to a drop in the price of oil. In the weeks to follow the debates over the budget cuts in Congress are likely to affect the price of oil via the changes in the US dollar.

China, among the leading importers of oil, has shown some signs of progress as its manufacturing production rose during November. On the other hand, the EU is still showing little to no signs of growth of its economy, which could result in a drop in demand for oil. Therefore, the direction of the demand for oil is unclear for now but some analysts expect the global demand for oil won't increase much mainly due to the weakness of Europe's economy.

The bottom line: I think despite the recent rise in the price of oil, and the uncertainty around the direction in the demand for oil, the recent changes in the supply suggest the price of oil might change direction and fall during the month and perhaps even reach the low 80s or even the high 70s.

For further reading:

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

Disclaimer: The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.

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