2011 Headwind #1 Spot Oil
Heading into 2011, I identified energy as the sector that I expected to the lead the S&P 500 Index to another higher yearly close. Certainly, an orderly appreciation in the spot price of oil would contribute to that outperformance. Unfortunately, the unrest in MENA (Middle East Northern Africa) has caused the appreciation of the spot price of oil at an uncomfortably fast pace. The "overweight" QE2 trade from early September ended in late February, concurrent with a $10 jump in oil prices. Figures 1.1 and 1.2 below highlight that correlation.
Elevated spot oil prices above $100 warrant downsizing risk from overweight to market weight. In the next few weeks, risks to further upside in spot oil prices are high. We are entering a historically strong pricing period for oil and its gasoline and distillate byproducts. In addition, a confluence of indicators beyond MENA unrest is supporting further upside for oil.
- Competition for global oil spare capacity has increased significantly since oil last traded above $100 in 2008. To that point, China just reported its second highest oil demand month on record, using 9.58 million barrels per day. There is no slowdown in Chinese usage of oil.
- The value of the U.S. dollar is defying the seasonal trend, continuing to deteriorate to a fresh 15 month low. Keep in mind that the first calendar quarter is generally a strong one for the dollar. The absence of strength this quarter is of concern to me. This past week, we traded below the 2010 low; I expect the 2009 low at 74.22 is next. (see Figure 1.3)
- Optimism regarding securing the Japanese nuclear facilities has shifted the focus from potential demand destruction to the reconstruction efforts. A potential $300 billion price tag for earthquake and tsunami damage will increase the domestic need for hydrocarbons throughout the multi-year Japanese rebuilding period.
- U.S. domestic gasoline demand remains strong while inventories continue to dwindle. (See Figure 1.4)
All of this is creating discourse within the capital markets and has established the 2011 Headwind #1 as the Spot Price of Oil.
Figure 1.1 S&P 500 Index August 2010 - March 2011
Figure 1.2 Spot Crude Oil August 2010 - March 2011
Figure 1.3 U.S. dollar March 2008- March 2011
Figure 1.4 Gasoline Inventories 2009-2011