Oil's Rally is for Real

Energy Strategist (11/18/2009)
"A sizeable population of pundits is permanently bearish on crude oil prices. Earlier this year, when oil still hovered around USD40/barrel, plenty of bears predicted that oil prices would slump to USD20/barrel by the end of 2009.

And even as oil prices headed higher in the spring, several of these prominent bears continued to fight the tape, claiming that the 'fundamentals' didn't support the rally in oil prices. As the rally continued some of the most prominent bearish arguments attributed the rise in oil prices to a weak dollar and/or the nefarious machinations of a group of speculators on the NYMEX futures market.

And this isn't a recent phenomenon. The Energy Strategist turns 5 years old next March; in the first month of its publication, I was invited on a radio show to discuss energy prices. I spent most of the 20-minute segment debating the path of oil prices with the host, who maintained that U.S. oil supply and demand conditions didn't support crude prices above USD50 a barrel—a level that was considered elevated at the time.

The relationship between U.S. inventories and oil prices has continued to deteriorate over the past year and a half. The big run-up in crude inventories from mid-2008 through early 2009 appeared to validate the oil bears' thesis; inventories rose sharply, and crude prices fell precipitously during the financial crisis. But in 2009 oil has soared to over $80 a barrel, even as inventories continue to hover just off 20-year highs.

The relationship between U.S. oil inventories and global crude oil prices is broken for the simple reason that most of the marginal growth in oil demand is coming from the developing world. Viewing U.S. oil supply and demand numbers in a vacuum no longer suffices as an accurate proxy for movements in global oil markets. Nevertheless, a number of bearish analysts continue to trumpet the inconsistencies between U.S. inventories and global prices as unsustainable and the precursor to a major collapse—the same mistake they made in 2005 and 2006."

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