Oil Riding High on Optimism

by Conley Turner

By the close of the week the breakout of crude oil from the upper band of its trading range was in full effect. The move occurred in the wake of a slew of favorable economic data and an overall positive shift in market sentiment.

The American Petroleum Institute (API) released data on Tuesday indicating a drawdown in crude oil supplies in the previous week. On the heels of that was a similar report from the more closely watched Energy Information Administration (EIA) which also showed a decline in crude stocks. The EIA stated that crude-oil inventories declined by half a million barrels for the week ended September 24th. Likewise, gasoline supplies registered a 3.5 million barrel decrease as did diesel and other distillates. These reports together point to an eventual uptick in energy demand as economic activity appears to be increasing.

The U.S.Commerce Department also released some favorable data during the week. Gross domestic product, which is the broadest measure of the country's economic activity, was shown to have grown at a pace of 1.7 percent in the period according to the government agency. While this is by no means robust, it was still superior to the market expectation of a 1.6 percent rate of growth. The Department also released by at the end of the week showing that U.S. personal income increased by 0.5 percent and personal spending by 0.4 percent in the month of August.

Continuing along this positive thread for oil prices was a separate report showing that as one of the world's most prolific consumer of crude, manufacturing in China saw an upswing in the September. That country's government affiliated China Federation of Logistics and Purchasing indicated that it's Purchasing managers' index rose to 53.8 in September from 51.7 in August. A number above 50 conveys a pickup in manufacturing activity and by extension, the potential for an increase in oil consumption.

Also, while always lurking in the background, a geopolitical flare up occurred on Friday which had an impact on the price of oil. A series of explosions in Nigeria's Capital evoked some nervousness among oil traders and investors about the resurgence of violence against that country's oil infrastructure. Militants in the delta region of Nigeria had dramatically scaled back the frequency of their attacks in recent months after the implementation of a government sponsored initiative aimed at addressing their grievances. However, dissatisfaction has begun to set in and fears are emerging about a new round of violence. This is an important development as Nigeria is a member of OPEC and among the top three oil suppliers to the U.S., ahead of Saudi Arabia.

Along with these factors is the fact the dollar index continued its slide against a basket of other international currencies including the euro. By week's end, the index had swooned to its lowest level in approximately eight months. The price of crude oil is inversely related to value of the dollar and as such, a cheaper dollar makes the commodity more attractive to holders of other currencies. To this end, the euro ended the quarter with the best quarterly gain in eight years.

The specter of quantitative easing is also having an impact on crude oil prices. In the most recent FOMC meeting on September 21, the governing body conveyed that the option of expanding monetary policy in the U.S. would be exercised should the economy start to falter. Such this actually occur, the action will result in the number dollars in circulation increasing significantly thereby causing a rally in dollar-denominated commodities such as oil. Crude oil has risen by about $9 higher since that FOMC statement.

It is clear that market participants are focusing on the positives about the economy and by and large discounting the negatives. The news flow in recent days has been rather optimistic and investors have been demonstrating their enthusiasm by putting money to work. As a direct result of this, the Standard & Poor's 500 Index recorded its best September performance since 1939 and that momentum remains in place.

Similarly, the price of oil has risen by approximately 10 percent during the month with about half of that gain occurring in the past week alone. Now that crude has broken out of its trading range, the clearing of this hurdle coupled with the momentum could see the commodity easily surpass the $82.97 per barrel level attained at the start of August.

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