Under The Hood Of Crude’s Rally: Supply, Demand, And Bernanke

by on July 17, 2013 | ETFs Mentioned:

In the world of commodity investing, there is perhaps no resource as critical as crude oil. While traders embrace the fuel’s inherent volatility and potential for lucrative returns, the rest of the world views crude oil as a crucial ingredient to everyday modern life. As such, the price movements of crude oil are closely watched and the commodity’s recent rally has already begun to raise several red flags [see 25 Wild ETF Charts From 1H 2013].

Over the last few sessions, investors have seen West Texas Instrument (WTI) crude oil surge above $106 a barrel. Just last week, oil prices gained 2.6% following Fed Chairman Ben Bernanke’s commentary, which indicated the central bank’s unwillingness to make rash decisions on raising interest rates. Though there is a fair amount of uncertainty concerning both domestic and global economic well-being, the fundamentals behind crude oil don’t seem to be lining up behind the fuel’s recent price action.

Supply, Demand, And BernankeCrude Rallies

No one can argue that since the Fed began its unprecedented round(s) of quantitative easing, market fundamentals have seemingly faltered. Basic supply and demand are no longer the drivers of price movements in crude oil, rather speculative rumors and whispers of further easing have created an uncertain environment that fosters a market filled with traders simply executing positions based on the latest news article or tweet [see The Curious Case of Silver ETFs].

Simply put, crude’s current value does not accurately reflect its actual market. The U.S. is rapidly increasing its presence in the oil space and has been the beneficiary of some hefty finds over the past few years, giving it the capacity to increase supply. In 2012, the U.S. produced more than 2.3 billion barrels of oil – or 6.5 million barrels a day.

Because of this surge in production, the actual issue with the supply side of crude is logistics. The U.S. is currently not equip to accommodate such a high volume of oil; for example, oil from Canada and the Midwest flow into a key storage point at Cushing, Oklahoma, but moving oil south to refining centers on the Gulf of Mexico’s coast isn’t as easy. This, as well as several other bottlenecks, however, are already in the process of being removed as extra pipeline and refining capacity have come online [see The Cheapest ETF For Every Investment Objective].

On the demand side, however, the picture is not as clear. From a long-term perspective, the world is (very) slowly starting to use alternative sources of energy; natural gas, for example, is now more commonly used in households for heating instead of oil. In the near future, however, a turnaround in the global economy will certainly spike demand, but investors must also keep in mind the ability of rising supplies to counteract higher consumption.

Just last week, the Organization of the Petroleum Exporting Countries and the International Energy Agency reported that demand for OPEC oil next year will fall well below current production, citing that the surge in U.S. shale has forced OPEC to cut oil production for the first time in five years.

But now back to Bernanke. The Fed Chairman has developed an uncanny ability to sway the volatile crude market in either direction, and as such, investors should keep in mind that while fundamentals are telling you one thing, the price movements of crude may go the opposite direction simply based on the central bank’s commentary [see 3 Seasonally Hot ETF Sector Trades].

For those looking to make a play, there are several ETF options:

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Disclosure: No positions at time of writing.