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Crude Marches On?


In China, demand outpaces supply.

Crude oil continues to frustrate traders on both the long and short side as $5+ daily swings have become the norm. Many traders believe that excessive volatility can often signal an inflection point is near. Could we be near a top in crude? Let's look at some of the fundamental data to see what we can learn.

First, I would like to highlight the Commitment of Traders data for crude futures. Historically, commercials would be maximum net long about the time crude would bottom, and be maximum net short about the time crude topped. This relationship began to change around February of 2007, which was the last time commercials were net long (and when crude bottomed at $50/barrel).

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Since February of 2007, crude has marched higher – often times as commercials were buying on the way up (as has been the case recently). My interpretation of the COT reports will remain bullish as long as this continues.

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Another important fundamental driver I look at is demand from China. As you can see from the chart below, demand for crude oil has continued to ramp.

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And as China's demand for crude oil grows faster than domestic supply, the Chinese must purchase crude oil on the international market. This demand shows up in the form of crude oil imports.

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Last, I wanted to highlight a new trend that has emerged in China. Until recently, China could satisfy most of its refined product demand. But price controls imposed by the government restrict the price for which refiners can sell refined crude product. Therefore, as crude prices rise, it has become more economic to import refined product (such as gasoline) than to refine and sell at a loss. This is a new trend and will need to be monitored.

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While crude appears to be a bubble, the global fundamentals appear to be intact. That doesn't mean we can't see a $20-30 pullback in crude. After all, the sharpest corrections often occur in bull markets. But I continue to look for weakness to add to positions in energy growth companies as opposed to trying to short energy here.

As for energy growth companies, I have been looking down south of the border for companies with similar profiles to BPZ Energy (BZP), a stock I highlighted over a year ago when it was trading below $5. Some of the names I am looking at include: Pacific Rubiales (PEG.TO), Solana Resources (SOR.TO), Gran Tierra Energy (GTE), and Petrominerales (PMG.TO).

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No positions in stocks mentioned.

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