Oil and the Dollar: Which is the Tail, Which is the Dog?
Created by EQUITIES Magazine
An economic recovery may spark more use of oil products, but is there too much supply?
Most Americans could care less about the price of lean hogs, but the price of gasoline and heating oil always gets their attention. With the exception of natural gas, light sweet crude, heating oil, and a host of commodities took off six weeks after the stock market posted its March lows, threatening to dampen any economic recovery.
While a two-week correction interceded, oil and gas prices took off again in July and August, prompting Rude Awakening’s Chris Mayer to compare the stubbornness of the price of oil to “a two-year-old who refuses to eat his mashed peas.”
“Despite all evidence that the market is well supplied, oil is over $70 a barrel again,” Mayer wrote in his August newsletter.
Part of the reason, he explains, is oil is denominated in dollars. But he then goes on to argue that the logic may be the other way around; that dollars are denominated in oil. Part of oil’s rise, he says, is simply because of the marking down in the value of the dollar. For example, a weak dollar spells higher oil prices.
Does this spell doom for oil prices and a welcome break for motorists at the pump?
Highly regarded energy analyst Peter Beutel, president of Cameron Hanover and a colorful CNBC guest, doesn’t see justification for the price of oil going higher.
“A great deal depends on the economy,” Beutel says. “Right now, if it were just supply and demand, oil prices would be dramatically lower—probably around $50. But a large part of it has recently been the buying based on an assumption the economy would improve, based on what they are seeing in stock prices, and those prices have been moving higher lately.”
If the dollar starts to go higher, there is a good chance that it will take a little wind out of oil prices, he reasons, going on to point out that from a supply-and-demand standpoint, $70 oil doesn’t make sense.
From a supply standpoint, distillate stocks (diesel, fuel oil) are just coming off a 24-year high with 30 million barrels more than a year ago, he says. Beutel adds that crude oil stocks were making multiyear highs in April and May and that there is plenty of crude oil out there—50 million barrels more than a year ago—and that gasoline stocks are about 3% higher than a year ago.
In face of this supply, demand for all oil products is only up about 3.15%, he says, adding that the only demand number that is higher versus a year ago is gasoline, and that’s only up 0.5%.
Distillate demand is down about 8.7% to 8.9%, and it’s been down as much as 14% over the last few weeks. So basically, you have poor demand and plentiful stocks, Beutel says. If those factors were allowed to be the main factors in the oil market without the dollar or the stock market being a factor, then we would be lower, he says.
But $70 a barrel isn’t deterring China from buying. Bloomberg.com reports that China imported record amounts of crude in July, up 18% to the equivalent of 4.6 million barrels a day. “We’re seeing less consumption in OECD economies but more consumption in places like China,” Francisco Blanch, head of global commodities research at Bank of America’s Merrill Lynch, says in the report.
Which is the tail and which is the dog?
“For now, the commodities are definitely being wagged by the currency,” Beutel explains. He adds that for 25 years—from 1982 to 2007—nobody really cared what happened to the dollar, and it wasn’t a major factor in oil. It’s really from two years ago in 2007 that it became a major factor, and the question is whether it is going to continue to be a factor or whether index funds and exchange traded funds become less of a factor with all the Commodity Futures Trading Commission rules that are coming down the pike.
Currently, the CFTC officials have been holding hearings to determine whether to place limits on holdings of energy and agriculture products and whether players with deep pockets distort the markets with a target date for a decision sometime in the fourth quarter. The CFTC has been sharply criticized for its lax oversight when commodity prices soared to record highs last year driven by heavy speculation.
According to Beutel, that may be something that will change because the people who run the index funds and ETFs tend to look at the dollar or at equities and look more at outside factors as reasons for buying. They don’t tend to know as much about the fundamentals. They look at the dollar and say, “Let’s buy all commodities,” or at equities and say, “Oops, the economy is getting better, let’s buy commodities,” but they don’t look very deeply.
While Beutel doesn’t recommend stocks, he goes as far as saying that stocks with oil in the ground are going to do well in the long term. “We are not done with the oil markets, just the fact that prices are lower and the fundamentals are bad right now,” he says. “Over a five- or 10-year period, we are going to need oil and will continue to have these occasional spikes that are going to take oil to higher levels.”
Thomas Choi of Altos Management Partners Inc. casts a solid vote for buying natural gas stocks, explaining that its clean burn and obvious benefits from legislation to tax or limit carbon emissions will benefit exploration and production companies, such as BHP Billiton Ltd. (NYSE: BHP), Chesapeake Energy Corp. (NYSE: CHK), Anadarko Petroleum Corp. (NYSE: APC), Precision Drilling Trust (NYSE: PDS), Schlumberger Ltd. (NYSE: SLB), and Cheniere Energy Inc. (AMEX: LNG).
Kurt Wulff of McDep LLC, an independent energy investment research company, identified three natural gas stocks that were undervalued according to the McDep Ratio. The companies were Cimarex Energy Co. (NYSE: XEC), Dorchester Minerals LP (NASDAQ: DMLP), and Hugoton Royalty Trust (NYSE: HGT).
By George Brooks
