Is The Oil Market Heating Up Again?

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During recent weeks the price of oil has rallied. One of the reasons many investors attribute to the recent rise in oil prices is the tensions in Algeria. The colder than anticipated weather in Europe and the U.S. is also another factor for the rise in demand for heating oil. Is the oil market heating up again? Will oil prices pass the $100 mark and maintain that mark for a long time? Let’s analyze the recent changes in the oil market.

During January (up to date), the price of oil increased by 4.1%; United States Oil (NYSEMKT: USO), by 4.2%. The recent rise in the price of oil coincided with the rise in other energy commodity prices such as natural gas and stock markets such as the S&P500 index.

The rise in the price of oil might have positively affected the revenues of major oil companies in recent weeks. Following the rally in oil during January, some leading oil companies's stocks have also traded up. During the month, shares of ExxonMobil (NYSE: XOM) rose by 4.91%; shares of Chevron (NYSE: CVX), by 6.6%. Moreover, the linear correlation between the stock price of Exxon and the changes in the price of oil reached 0.54 during last year; the correlation between Chevron's shares and the price of oil was 0.56. These correlations suggest, at face value (assuming linearity and normality of figures), that the price of oil could explain nearly 30% of Exxon's stock volatility and 32% of Chevron's volatility. These relationships should be taken with a grain of salt, but imply that if oil prices will further rally, they could pressure up the stock prices of these oil companies on account of their potential gain in valuation.

So let's turn to examine the fundamentals and see if oil prices are likely to rise again.

Geopolitical tensions

The tensions between Iran and Israel took the back seat in recent weeks and now the latest developments in Algeria are posing some concerns that this could impede the production rate in this OPEC member. The memories of the civil war in Libya a year and a half ago are still fresh in the minds of many oil investors. Keep in mind that the current situation in Algeria is still far from the geopolitical situation in Libya in 2011: Algeria produces around 1.2 million bbl/d while Libya (pre-war) produced around 1.6 million bbl/d. Algeria is the third largest African oil reserves holder, Libya is the largest. Moreover, the current OPEC oil production is higher than its production rate back in 2011. Therefore, I suspect the impact of an escalation in Algeria on the oil market is likely to be weaker than the impact of Libya's civil war it had on the oil market back in 2011.

Storage

During December and January, the U.S. Petroleum and oil stockpiles rose by 7.7 million barrels; it reached 1,799 million barrels by January 11. The current oil stockpiles are 51.5 million barrels above the storage during the same week in 2012. The recent rally in storage and the relatively high storage (compared to last year) suggests the oil market is loosening up. Moreover, the linear correlation between the changes in stockpiles and oil prices is mid-strong and negative, which suggests if oil stockpiles will continue to increase, it could pull down oil prices.

Supply

From the supply side, according the latest EIA report, the U.S oil production increased during December and January by 2.4% and as of January 11 was by 20.4% higher compared to the same week in 2012. Refinery inputs, on the other hand, slipped during the month by 0.9%, but were 3.7% higher than last year. Finally, imports also decreased by 5.3% during December and January. The drop in imports could have contributed to the recent rally in oil prices during recent weeks.

The chart below presents the developments in oil imports and the changes in oil prices on a weekly basis during the year. The linear correlation between these two data sets is -0.39. This relation suggests, at face value, that if imports will continue to fall, it could positively affect oil prices.

The higher than last year's refinery inputs could have partly explained the recent rally of major refineries stocks including Valero Energy Corporation (NYSE: VLO) and Marathon Petroleum (NYSE: MPC) during recent weeks: shares of Valero rose by 11.1% during January; shares of Marathon Petroleum, by 6.7%. Despite the rise in oil prices and refinery inputs during 2012, these companies' operating profitability hasn't augmented: In the third quarter, the operating profitability of Marathon Petroleum reached 9% compared to 8.5% in the same quarter in 2011; the operating profitability of Valero Energy reached 3.8% compared to 5.8% in the third quarter of 2011. Nonetheless, if the refinery industry will continue to grow, it is likely to reflect in major refinery companies' revenues and profitability.

Demand

From the demand side, the U.S economy is showing a mixed signal as to the progress of the economy: the Philly fed index for January declined; the housing starts spiked in December. If the upcoming U.S reports will show signs of growth, they could suggest a rise in the U.S demand for oil, which, in turn could lead to pressure up the price of oil.

The recent drop in temperatures across Europe and the U.S may have contributed to the rise in demand for oil for heating purposes (e.g. propane). Currently it seems the winter in the U.S won't be as hot as it was in 2011/2012. In such a case, the demand for heating purposes is likely to further rise, which will keep oil prices from tumbling down.

The bottom line

My guess is that the recent rally in oil prices won't last long and unless there will be any new unexpected developments in the oil market (an escalation in Algeria), oil prices are likely to slowly come down in the coming weeks.

For further reading:

Big Swings for Oil; where will Oil Price Land?

Will Exxon Continue To Trade Up?

 


liorc has no position in any stocks mentioned. The Motley Fool recommends Chevron. The Motley Fool owns shares of ExxonMobil. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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