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Is Oil Over-Bought?

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By CryingofLot49
June 4, 2008

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'Bad headlines notwithstanding (e.g., the deteriorating oil supply/demand outlook as per last week's IEA report), there are signs the oil market is overbought. The chart below looks at "floating tonnage", the amount of oil sitting around on a tanker with no place to go. During the 1990s, oil prices were $20 and floating tonnage was around 4 million tons.

When oil prices took off in 2002, floating tonnage fell to zero. That made sense, since a scarce commodity everyone wants shouldn't be sitting around with no takers. Then a couple of months ago, as oil prices kept rising, floating tonnage rose from zero to 4 million tons again. Tanker rates then skyrocketed since there's competition for oil storage capacity.

This may reflect a surplus of Iranian crude, which is harder to refine, but if so, why isn't there a greater price difference between Iranian crude and "lighter" benchmarks such as WTI? To us, it suggests that demand is falling, and that prices are out of whack.

If oil prices fell, it would be consistent with another "sure thing": metals prices. In the summer of 2006, Chinese urbanization was seen as the unstoppable demand source for industrial metals. Yet since that time, nickel, lead and zinc prices have fallen by 50%, and both copper and aluminum prices are unchanged vs. their peaks two years ago.

With the OTC oil derivatives market now 26 times the size of the open interest on the NYMEX exchange, the stage is set for oil prices to decline at some point, perhaps sharply. '

~'Soylent Greed,' - JPMSI