Saudis Know Oil

By Dr. Duru written for One-Twenty

January 17, 2007

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Back in late November, I wondered whether oil had reached a bottom in price. I suspected that oil couldn't get much lower without some economic woes hitting the scene. Boy was I ever wrong! If you have not heard yet, oil is down over 15% this year alone. Some OPEC members are starting to panic and want to get some more production cuts in to stem the bleeding. The calm, steady voice you hear muscling its way above the madness comes from the Saudis. They have essentially told everyone to calm down - nothing to worry about here. The oil market is fine! When I read the reports on the Saudi reaction to this year's decline in oil, I am reminded of the sure voice of the Saudis last year when oil was ripping and running to $60 and $70 dollars per barrel. Back in early summer or so, the Saudi oil minister told us that oil inventories were building fast and even suggested that oil prices were too high. I have read a lot of opinion and counter-opinion on oil lately, and I think I am going to put my money on the Saudis again. (Note that they control the world's largest proven reserves of oil).

I also suspect that oil politics will weigh in heavily on oil prices. The heavy consumers of oil of course always have every reason to want oil to fall. But the U.S. in particular would love to take oil money out of the hands of countries like Iran and Venezuela. And these same places have every reason to sabre rattle as much as possible to drive the risk premium on oil back up. Hugo Chavez in particular needs higher oil prices to fund his socialist initiatives in Venezuela. I am not sure who wins this tug-of-war but when the machienry gets moving on one side of the bet, it really moves! These dynamics are another reminder of just how fast the money flows in the world of commodities. (January 18 update: I am now hearing several pundits adopt the idea that the Saudis want LOWER oil prices in an effort to check Iran's ability to fund its growing influence in the Middle East. Interesting! The drama, as we say on the "streets," is getting THICK.)

I post a weekly chart of USO below to show how volume on the oil instrument has continued to build. In November, I noted the volume as a potentially bullish sign. And while I was burned on that one, I still have to wonder who is on the other side of those trades? "Somebody" is accumulating USO, and probably oil futures. "Someone" thinks oil is too cheap and is willing to take on the sellers. Perhaps the buyers are listening more to the Saudis than weather reports or the bearish traders who have the current upper-hand in oil pit manipulation. Cold weather across the country this week will remind us that Mother Nature is not yet ready to revoke the notion of Winter. William Trent demonstrates that while inventories (days of supply) are building in the short-term, inventories have been in a long-term decline for over 15 years. Hmmm.....

USO weekly chart

Be careful out there!

DrDuru, 2007