Bert Dohmen , Contributor
In the past, the usual “oil crisis” was caused by self-serving news items of an oil shortage, causing soaring prices. Just 2-3 years ago, the fear mongers said that the world had “seen peak oil,” meaning that oil production would be on a long term decline and there would be big shortages. Instead, oil production is now at a high
The current crisis is one of plunging oil prices and a glut as far as the eye can see.
Oil production, after prices have fallen over 60%, is at a new high. As we predicted late last year, oil producers are making up for plummeting income by pumping even more. Rig counts in production are plunging, but these are from the low production wells. The high producers are still pumping away. In fact, the latest rig count even shows that there is little additional reduction in producing rigs.
The bulls say a bottom in oil prices is in place. That means the oil market isn’t even close to the final plunge. The eagerness to call a bottom is not what you see at a true bottom.
For a short period, this also keeps the supply companies working. That is, of course, until the production companies have to shut down. They have more than $210 billion of junk bond debt. Eventually, the defaults will cause a “credit event” in this sector of the financial markets. And that’s when oil production will diminish. A credit event means fears of an avalanche of junk bond defaults. It only takes one default to start that domino effect.
No one can predict the timing. However, the next plunge in oil prices will be very sharp. It will consist of dumping by the early bargain hunters.
The big negative is that so many money managers have been “bottom fishing” in the energy sector. Our analysis of financial history is that when there is such a commodity bust, it usually lasts for a long, long time, sometimes 20 years. And money managers, who for years and decades have used oil as the permanent investment, can’t change their habits.
It’s very possible that the price of oil made its top in 2008 at $147, a top that will be in place for 20 years. Are the perma-bulls on oil prepared for that?
We remember in the late 1970s, we were very bullish on gold. We rode it up all the way to the top. Then there was a pull-back. We said that if it breaks $694 on the way down, it would be a bear market. After the top in the year 1980, it did just that. We advised selling short.
Our analysis of gold over several hundred years, going back to the London market, led us to conclude the next bull market in gold would have to wait 20 years. That was considered ridiculous by the bulls. Most were waiting for the next gold upmove to $3,000. However, the gold bear market lasted until 2001, exactly 20 years.
Now the oil bulls think they are “contrarians,” when in reality they are part of the crowd. They may be like the gold bulls in the early 1980s. Gold eventually dropped to about $250 in that bear market. Every rally was a bear market rally. The same could happen to oil. After all, it is only a commodity and all the commodities are in very significant bear markets.
Another big source of new oil supply will soon come from Iran. There could be a deal between the U.S. and Iran soon on the nuclear question. Sanctions and embargoes against Iran would be lifted. Iran would again be a big exporter of oil. It certainly needs the revenue. That will open the floodgates.
It would exacerbate the global oil glut. The ensuing plunge in oil prices will chasten the current oil bulls. It could get vicious, as overleveraged speculators dump what they have in order to meet margin calls. A price below $30 could be seen within days.
Such a severe oil price plunge would cause a shake-out in the junk bond market. Bank stocks would also be adversely affected. Note that junk bonds have rallied from the plunge into the December low. We think it is a fools’ rally to allow some of the big, smart money to liquidate their positions at good prices. Our information says that there is no liquidity in this sector now. Any money manager wanting to sell a large amount can’t even get a reasonable bid. Apparently, the prices on the junk bond ETFs are artificial.
In a junk bond shakeout, all the commodities would tumble, and that could include gold and silver.
Be ready for some real turmoil in case there is an agreement with Iran. Washington really wants it and is willing to “give away the farm” to get it.
The Energy Information Administration (EIA) said crude inventories climbed by 9.6 million barrels for the week ended March 13. A new record high of 458.5 million barrels of U.S crude in storage was reached. This is about 70% of Cushing’s storage capacity.
The chart below of crude oil (weekly) shows the new lows being made, even while vested interests try to push the stocks of energy-related companies upward to present the illusion a bottom is being made. We don’t like trying to catch a filling knife and therefore won’t participate in any bargain hunting at this time. The chart does not reflect a bottoming pattern.
The storage tanks are filling, and when they are full, there will be massive dumping. The recent bounce in the energy sector is technical in nature from very oversold levels. The probability of a true bottom having been made is as unlikely as snow in the Sahara.
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