OGJ Senior Writer
A “general Wall Street myth” that a second round of “quantitative easing” of the economy (QE2) should prove bullish for oil through the lower dollar index may prove bearish instead. QE1 was the Federal Reserve Bank's unprecedented purchase of debt to prop up the housing market and credit facilities for big banks.
“Our view is that QE is in reality bearish for oil,” said Olivier Jakob at Petromatrix, Zug, Switzerland. “First, QE is being applied because of a weak economy, and it is expected that the Fed will slash its US gross domestic product growth outlook for 2011. Low GDP is not good for oil demand.”
Second, he said, “Interest rates at zero and a contango structure transforms any oil storage tank into a money printing machine (and this is real dollars, not the sort coming from the Fed’s printing machine). This results in extreme high levels of oil [inventories], which act as a buffer and prevent oil rallies [from gathering] steam.”
Jakob said, “Third, the contango structure that is created by the high level of stocks kills all the economics of holding length in West Texas Intermediate indices.” While investors who bought gold during QE1 have done well, those who bought oil “are in the red,” he said. If new investors buy oil for QE2, those who bought oil during QE1 will be happy to offload their positions to them after learning the hard way the workings of the contango.
“While there can be some hype buying into WTI for QE2, both from a fundamental and from a financial basis, QE2 should provide a negative return on investments in WTI indices,” said Jakob. He later said, “The risk of trading crude oil as a derivative of the dollar is increasing and becoming too binary when the central banks are engaged in currency wars.”
Bulls look to last quarter
Jakob also noted, “The same financial institutions that were beating the bullish drum in the second quarter calling for massive stock draws in the third quarter are now doing the same for the fourth quarter. While we agree that there will be some seasonal stock draws in the US during the fourth quarter, we do not agree that they will be disruptive as they will be coming from a record-high base and will be organized and scheduled by the industry. If we consider that the last time there was a genuine tight oil market was at the end of 2007 [through] early 2008, then US petroleum stocks would need to draw 180 million bbl in the fourth quarter to reach the stock levels of end 2007 by the end of this year. That is a 14 million bbl draw each single week during the fourth quarter and will not happen.”
Moreover, he said, “To reach the ‘comfortable’ stock levels of end 2009, US stocks would need to draw 100 million bbl in the fourth quarter, which is a 7.5 million bbl draw in each single week. We doubt as well that this will happen.” Although lower than record highs, US inventories should remain well above their historical average in the fourth quarter, he said.
Meanwhile, the US dollar remains under pressure after the Federal Open Market Committee, the policy-making arm of the Fed, said Sept. 21 it is “prepared to provide additional accommodation if needed” to support the economic recovery. “But this only means that we will probably go deeper into the currency and protectionist wars,” Jakob charged. At the time, Congress was expected to vote soon on a Chinese currency bill. If Japan fails to intervene, he said, “We will nonetheless be ready for further intervention in days to come if the yen continues to rise. The dollar is also trading below the Swiss franc, and Brazil recently said it is ready in intervene in the market.
(Online Sept. 27, 2010; author’s e-mail: email@example.com)