Here Comes the Oil Bust

by David Frazier

Money News

June 2, 2008

Crude oil futures for July delivery rallied yesterday morning, following reports from the major financial media that crude oil inventories fell by a larger amount than “expected” for the week ended May 23. However, oil futures closed out the day down $4.53, after astute traders apparently read the latest oil inventory report from the Energy Information Administration (EIA).

Although yesterday’s report from the EIA showed that U.S. crude oil inventories fell by 8.8 million barrels in the week ended May 23, as compared to the previous week, the major financial media failed to mention that inventories declined primarily as a result of temporary delays in crude oil tanker off-loadings on the Gulf Coast.

The major media outlets also overlooked the fact that U.S. demand for oil fell in the week ended May 23 as a result of the ongoing economic slowdown in the U.S. and the adverse effect that higher petroleum prices are having on demand.

For example, the consumption of motor gasoline declined 0.4 percent over the past four weeks, as compared to the same period a year ago, while the demand for jet fuel fell 2.9 percent.

If the talking heads on CNBC and other financial shows had bothered to pay attention to some recent announcements from the airline industry and review production activity at U.S. factories, they might have been able to forecast the recent decline in the demand for oil.

For example, American Airlines, the world’s largest airline, announced on May 21 that it plans to reduce its flight capacity by up to 12 percent this year as a result of surging jet fuel costs.

That announcement follows a report from the Federal Reserve on May 15 which showed that U.S. factories cut back production for the fifth month in a row during April.

Those announcements clearly suggest that the demand for oil in the U.S. will likely continue to fall in the months ahead. The fact that gasoline prices are rapidly approaching $4 per gallon — which I forecast in an article on April 8 — also suggests that the U.S. demand for petroleum products will continue to fall.

Perhaps more importantly, the spread between the supply of, and demand for, oil has widened significantly over the past four months, as is clearly illustrated in a chart that I provided to our readers on May 20 (See my article titled “Oil Prices Greatly Extended — Expect a Significant Pullback”). In light of the fact that Saudi Arabia plans to increase its production of oil by 300,000 barrels per day in June, I expect the positive supply-demand spread to continue widening in the months ahead.

Although I expect oil prices to trend higher in the coming years, primarily as a result of substantial infrastructure building in China and India, my research indicates that oil will fall sharply over the next few weeks.

If you were considering investing in oil-related securities, you might want to reconsider your investment plans. Click here if you’d like to receive weekly emails from me on important developments in the financial markets and on ways to profit from those developments by investing in exchange-traded funds (ETFs).