This week saw this report on oil stockpiles from Reuters: "Total U.S. commercial stockpiles rose slightly last week by 200,000 barrels to hit a new 20-year high just above 1.143 billion barrels, the highest level since the EIA began issuing weekly reports in 1990." And yet, oil rallied in the last two weeks more than three dollars, as of yesterday trading $77.50 a barrel. What can make supply increase to historic levels and still allow the commodity to rise in price? It is "oil's endless bid." "Oil's endless bid" is what I have called the "assetization" of financial oil, working through index investment, ETF trading and dedicated energy hedge funds. They are all entering the futures markets without regard to the fundamentals that underlay the commodities. Oil's Endless Bid is also the title of my upcoming book from John Wiley and Sons, discussing this topic, which I believe is the most important financial story of the decade. But this week's EIA report draws this disconnect into such sharp and immediate focus. Let's discuss "oil's endless bid" briefly and try to understand how oil can rally while supplies continue to bulge. Commodities aren't stocks, but the financial industry has worked hard to make them look and work as if they are: They've created indexes, ETF's and managed funds that allow investors to access the price of the crude barrel as if it were a share of Chevron. And the investing public has glommed onto the products with both fists, causing index investing in commodities to increase more than 25 times between 2003 and 2008 to over 300 billion dollars in funds and increasing the number and market caps of futures based ETFs as well. The market-leading US Oil Fund ( USO) has had three share expansions since its inception and now trades an average of more than 9 million shares a day.
We can see some of these fundamentally negligible inputs have tremendous price effect this week, in spite of the EIA reports which would intuitively make one expect lower prices, not higher ones. Recently one of the larger Enbridge ( EEP) has pipelines pumping crude from Canada sprung another leak. I say another, because this system was the one responsible for the recent Kalamazoo, Mich. spill. Infrastructure like these pipelines have always been an issue and have become more of one, as many of these systems are approaching their 30-year anniversary of service. Still, it is hard to relate a short-term shutdown of this pipeline into the violent rally that oil saw because of it. More logically, traders overestimated the effect of a supply shortage and rushed to buy oil, expecting to take advantage of a rally. Just as influential, even though it should intuitively have an opposite effect, has been the recent stock market rally. As financial oil gets used as any other capital market, it is subject to the same capital inflows as stocks are. We have seen how closely the motion of oil and stocks has been even though intuitively they should move in opposite directions - after all, nothing is much better for business than a declining price for energy. And yet, as the stock market has rallied in the last two weeks, so has the oil market - in total disregard for supply surpluses. These financial inputs have meant more to the price of oil than the traditional fundamentals of supply and demand -- and are the reasons why oil can shrug off a 20-year supply bulge and still rally higher. "Oil's endless bid" has become the most important fundamental.
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