Oil prices have continued their rapid ascent today, with West Texas Intermediate crude at $47.88 a barrel as I write this -- an incredible 20% gain in just three trading days for the most liquid futures contract on Earth.
Or maybe it's not so incredible, with the word "liquid" serving as the key point.
Personally, I believe oil's move downward has been the product of relentless selling from speculators -- after all, it's really easy to short an oil-futures contract. And remember that the vast majority of oil-futures contracts never physically settle.
Technically, being short a WTI futures contract gives the counterparty the option to require physical delivery of petroleum to the Cushing, Okla., oil hub.
But check out the trading volume on an oil-futures-contract expiration day and you'll see that many contracts settle in paper form. (The world's other major oil-futures contract, which trades based on prices at Scotland's Brent terminal, are paper-only and don't allow for physical settlement.)
So, markets are often awash in "paper oil," or contracts that will never actually be exchanged for physical petroleum.
The existence of a physical oil glut is a lot harder to determine. Most players use supply statistics to try to divine oil's supply-and-demand balance, and currently, both domestic and international demand figures are quite strong.
The U.S. Energy Information Administration's "product-supplied" metric for domestic consumption looks solid, while China is importing oil at a record pace and has actually passed America as the world's largest crude importer.
But oil traders have seemed to ignore these metrics recently and focus solely on supply -- and it's positive news on that front that has driven WTI's rapid rise today.
The EIA reported earlier today that U.S. oil production fell to 9.296 million barrels per day in June, making clear that domestic output peaked in the spring and will continue to slide through 2015's remainder.
Actually, industry consulting firm Genscape published a piece last week noting this decline, with estimates much fresher than the EIA's 2-month-old data. Genscape's methodology also shows lower production than the EIA's figures, as well as a steeper slope of decline.
But traders didn't want to hear that last week, although I guess they do today. Fear and greed are how markets work, and the disconnect between oil traders and producers is striking.
I talk to C-suite executives in the oil-exploration and production sector every day, and believe me, not one thinks petroleum can remain below $40 a barrel for an extended period.
If you think this rally has legs, you should revisit some of the smaller stocks that are most leveraged to commodity prices. I've mentioned these five names in prior columns, and I've talked to senior executives at all of them in the past two weeks:
- Arabella Exploration (AXLWF)
- Goodrich Petroleum (GDP)
- HII Technologies (HIIT)
- Torchlight Energy (TRCH)
- Victory Energy (VYEY)
My own firm already owns all five.