A big part of the reason stocks have been levitating throughout February, with the major indices up 5% or more for the month-to-date, has been the recovering in crude oil prices. From a low of $43.58 a barrel in late January, prices rallied nearly 24% to a high of $53.99 earlier in the month.
Ostensibly, this has been due to a combination of short covering and excitement about falling rig count data (down 34% from the October peak) as well as capital expenditure cuts by drilling companies. That has, in turn, helped lift energy stocks and boosted stocks in general.
But the bullish case for oil prices is looking threadbare as the fundamental factors keep stacking against it.
Here are three reasons why I’m shorting the black stuff here.
Production
Click to Enlarge It’s worth remembering that OPEC’s decision to hold production constant — in a big to crush prices and win back market share from U.S. shale producers — means oil prices aren’t going to find a low unless the global economy revs up, OPEC reverses its decision or U.S. producers scale back on output.
The last of the three is the most probable. But as the accompanying chart shows, production continue to soar despite the drop in rig counts as producers pull out of less productive fields to protect profitability.
Yet this does nothing for actually bringing supply and demand back into balance.
Inventories
Click to Enlarge On Thursday, the U.S. Energy Information Administration reported that crude inventories rose for the sixth straight week, up 7.7 million barrels to the fourth straight 80-year high of 425.6 million barrels. Over the last six weeks, crude inventories have risen at the fastest pace in 14 years and the second fastest pace in history.
With onshore facilities bursting at the seams, we’re at the point that the cost and availability of floating storage is coming into play as hedge fund types buy and store cash oil to sell forward — capturing the “contango” profits. Once the floating storage play is maxed out, all that extra crude will hit the cash market, push prices down in a big way and potentially pull down futures prices as well.
The Dollar
Click to Enlarge As the chart above shows, crude oil is sensitive to the machinations of the U.S. dollar maintaining an inverse correlation: When the dollar is strong, crude oil is weak and vice versa.
Since last summer, the dollar has been on a tear on a combination of relatively strong U.S. economic growth, the simmering eurozone crisis and expectations that the Federal Reserve will raise interest rates this year for the first time since 2006. Also contributing has been a series of interest-rate cuts by foreign central banks.
These dynamics are likely to continue through the end of the year, keeping the pressure on crude oil.
How to Play It
Click to Enlarge In anticipation of a new slide in energy prices, I’ve recommended the ProShares UltraShort Crude Oil (NYSEARCA:SCO) to my Edge subscribers — a position that is up more than 8% since it was added on Wednesday morning.
I’ve also recommended a put option play against the U.S. Oil Fund (NYSEARCA:USO) to my Edge Pro subscribers.
Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters.
