I wanted to take a few minutes to review some of the fundamentals, technicals and other variables I look at on crude now that we have officially breached the $85 mark.

On the fundamental side, I like to look at Chinese demand. The chart below shows that China’s appetite for oil continues to grow. Remember, economic growth requires additional oil because it is constantly consumed. We would need to see an actual economic contraction to have oil demand go down. So far, we are not seeing that with the Chinese.


Click here to enlarge.

One of the best correlations to oil (I like to use Brent) price seems to be Chinese consumption. By running a regression, I can get a feel for whether oil is over/under-valued based on supply/demand fundamentals. Currently, Brent crude appears to be overvalued by about $10 to $15 USD, but that does not mean it is about to correct. Overbought can stay overbought.


Click here to enlarge.

Technically, I like to look at the COT reports to see what commercial traders are doing. Currently, commercials are net short about 65,000 futures contracts headed into the shoulder months. Typically, we see some sort of correction in crude while commercials begin to reverse their net short position (and eventually go net long) as we head into winter, where demand can be 5-10% higher than the spring/fall (“shoulder months”). The most recent data point is from last Tuesday so we won’t see what commercials did during the last move up until the next report is released on Friday. Currently, commercials are approaching a net short position that normally signals a near-term top.


Click here to enlarge.

Technically and fundamentally, crude appears to be overbought. So what’s driving the price higher? I get this question daily from other traders. The fact that nobody can put their finger on the exact cause for the rise in crude may be in itself very bullish. I have discussed peak oil in the past on Minyanville. Perhaps the world is not capable of producing much more than 85 mln barrels of oil per day. Demand is currently pushing that number now. If the global economy continues to expand and supply is truly constrained, we could be entering a new ballgame. This winter will be the big test (when demand picks up again).

Additional factors to consider are the weakening dollar (most oil is still priced in $USD) and geopolitical tensions (Iraq, Iran, and now Turkey threatening the Kurds). One has to wonder if the current move up in crude prices is more speculative in nature, or if we are really entering uncharted waters. Only time will tell. For now, the trend is up, but there are several warning signs emerging of a near-term top.