Oil Prices Are Under Pressure: Is It Time to Buy?

Source: Thinkstock

Source: Thinkstock

Just a few weeks ago, the world was concerned about social unrest in Iraq. Combined with tensions between the U.S. and Russia (the second or third largest oil producer in the world after the U.S.), many analysts were reporting that $150/barrel oil was just around the corner. But as is often the case, the crowd was dead wrong, and the price of oil has fallen by about 5 percent in the past month. Furthermore, the large-cap and mid-cap oil ETF that is most heavily correlated to the price of oil — the SPDR S&P Oil Exploration and Production Fund (NYSEARCA:XOP) — has fallen back from its June 23rd high of $84/share to just over $78/share.

Several things have been driving the price of oil down lately. First, there were too many speculative longs in the market. As I mentioned, the crowd had turned bullish, and while there were good reasons for them to be bullish, too many investors were making that bet, and when we didn’t see a political crisis immediately escalate in Iraq traders exited the position to look for another short term opportunity.

Second, the U.S. “officially” became the world’s largest oil producer, as Bank of America (NYSE:BAC) reported that it had over taken Saudi Arabia as the holder of this title (some reports state that Russia produces more than Saudi Arabia, although the difference is minor and it really doesn’t matter so much.) It achieved this not because other countries saw production declines, but rather because it grew production, thanks to the rapid rise of hydraulic fracking. With this being the case, the additional supply drove prices down.

Third, we have seen some weak global economic data, especially out of Asia, and if the economy is weakening then demand for oil declines. Investors should note, however, the strength in other economically sensitive commodities — particularly base metals such as copper, zinc, lead, and silver — and so this may not be a legitimate reason.

Fourth, the Federal Reserve announced that it would stop its quantitative easing program in October, and this has had a negative effect on oil and stocks, although again we are seeing recent strength in Treasuries (the asset that the Fed will stop buying) and metals (e.g. the base metals and gold.)