A Crude Spike Is Not a Given

 | Jul 22, 2014 | 2:00 PM EDT
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Oil, as represented by Nymex futures of West Texas Intermediate (WTI), has been puzzling to many recently. With one eye on the continuing crises in Syria and Iraq, and the other firmly fixed on the antics of Russian President Vladimir Putin -- which look more like an ill-fated arrogance every day -- many observers have concluded that the only way for oil is up. A basic analysis of a two-year chart for WTI confirms that view. You don't need to be a chart-reading genius to perceive an upward trend here.

Source: Nasdaq.com

But for those holding that view, here's what's been frustrating: While this year has seen a series of higher highs and higher lows, WTI is still a long way from last year's high of $110 per barrel. We have been lurching from one geopolitical crisis in an oil-producing area to another -- so, if this is all you are considering, that seems almost impossible. What is often forgotten, though, is that the biggest supply issue affecting WTI prices right now isn't coming from overseas. That title goes to the incredible and continuing boom in domestic production.

There is, as of now, no sign that the shale revolution -- that is, natural gas -- will be slowing down in the near future. Even deepwater drilling is beginning a resurgence following the moratorium after the BP (BP) Horizon oil spill in the Gulf of Mexico. In short, while supply elsewhere is threatened, the crude oil that is the basis of WTI is flowing ever more freely.

What is driving WTI in that clearly visible upward trend is actually more related to demand than it is to supply. It is easy to look around at solar power, electric cars and other technologies that reduce dependence on oil, and to lose sight of the fact that demand for oil is still growing. In fact, according to the 2014 BP Statistical Review Of World Energy, the global consumption of oil grew at a higher rate than the historical average last year. As long as demand continues to increase it will remain fair to expect that the price will do so too, even as new reserves are opened up, given the finite nature of the resource.

All of this is true, but two things are often overlooked by those looking for a spike in oil prices. First, that upward pressure on price, while real, is very slow. That "better-than-average" growth in oil consumption that I mentioned earlier is actually a 1.4% year-on-year increase. Given that, the 11% rise in WTI so far this year already looks a little overdone.

Second, the market is very wary of rapid moves upward at these levels, no matter what the impetus. WTI is very close to levels at which, historically speaking, higher U.S. oil prices have had a direct detrimental impact on the American, and therefore global, economy. In the past, the $110 level in WTI has equated to national average gas prices of around $4 per gallon. That, in turn, has been the price that has affected economic activity.

It is not that WTI crude can't or won't go up from here. It's just that those focusing on problems in the Middle East and Russia assume that it will happen soon -- and are quickly proven to be mistaken. There are other, bigger influences on crude, and on WTI in particular, that will keep that upward move in check. These influences will cause a rapid drop if, God-willing, peace breaks out around the world.

That is why, far from seeing WTI crude as a one-way upward bet, I would be more inclined to view each push up as an opportunity for a near-term short position.

Editor's note: Tillier is a regular contributor to Oilprice.com.

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