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  1. Home
  2. / Investing
  3. / Energy

What's the Ideal Level for Oil?

Another 10% drop would put it in the sweet spot.
By JIM CRAMER
Dec 26, 2014 | 08:52 AM EST
Stocks quotes in this article: HK, GDP, LPI, SD, ECA

Where do we want oil to be if we want the market higher? Where should it stop going down?

Right now we are still in the mode that, when oil goes up, the S&P 500 goes higher on a given day, even as we know from the long run the averages have had that the daily basis is quite contrary to how the averages have done overall. In other words, it's actually been terrific for the averages that oil falls, but it doesn't seem so on a minute-to-minute basis. The big down days have hurt the averages. The meandering days then help them and we have had far more meandering days than big down days. That's because, as I like to say, it's always the velocity-- not the direction -- that freaks people out and if there is no velocity then everyone's pretty sanguine.

So, with that, I think that the ideal level for the bulls might be about 10% lower. That's because it's still worth drilling on the good properties at $50 while others are on hold and the marginal producers slowly get taken down. Again, remember, it's the speed not the price, and at $50 we get gasoline at about $2, which seems to have an almost miraculous effect on the consumer without causing massive bankruptcies and a destruction of the high-yield market.

Anything in the $40s and there is going to be so much fretting about bank failures and high-yield defaults that it might derail a bullish tape. Anything in the $60s would have a deleterious impact on consumer spending.

It stands to reason that people are justifiably skeptical of this new level. They should be. I think investors are wondering what the heck happened to the $80s, $70s and $60s that we sliced through them so quickly after hovering in the $90s for so long. I think that it's obvious: the financial buyers were long and selling futures, the European and Asian buyers had been curtailed on economic weakness and the United States and Russia had a surge in production, the first from the Permian and Eagle Ford and natural gas liquid areas of Texas, the second just a need for raw currency. With that imbalance, the Saudis would have been expected to take a million barrels a day out of production and it didn't happen.

Which means the whole time we were artificially at an inflated level and it didn't take nearly as much as we thought to get to a realistic level. I know many think we can't stay down here, but the figures out of Texas, the new oil soon to be pumped out of the Gulf of Mexico as the wells that had been held back by Macondo start paying off, and the ferocity with which Russia is selling oil would certainly indicate otherwise. Cutbacks now will not be felt until 2016, simply because of how much is still being drilled right now.

At this level the savings are so great that we will keep having good comparisons in consumer spending without a resurgence in inflation in this country and we should have some sort of pick-up in consumer spending in Europe. If Russia were to make a deal with the west over Ukraine, I think we could have a substantial rally based on second half international earnings.

Why am I not that worried about bankruptcies now in the oil patch? I think it's because so many of the hedges run out -- including big ones like Pemex -- at about the same time that production should begin to be curtailed and demand picked up. I am not that worried about production in Brazil, it will stay stable. But drilling will be curtailed and I think it makes it to when oil starts climbing from economic growth. That's why I think that Boone Pickens is so optimistic about the end of next year. The combination of the hedges keeping more producers in business and coupled with a return to stronger business conditions should take the market back up, I just don't think it will return to the $90s because there's too much that goes right as long as we stay at a level where there's low-to-no profits. In other words, it still pays to drill and for most of the good places in the U.S. the oil will keep pumping from the high-priced wells, just enough to make it so earnings are nil for many, but cash flow covers debt for all but those who bought last.

Everyone's watching Halcon (HK), Goodrich (GDP), Laredo (LPI) and SandRidge (SD) to measure the stress. I think the focus should be on Encana (ECA) because that one's so much larger than the worrisome four smaller producers that were, frankly, worrisome before the downturn.

So, we meander, looking like we don't take out $50, but $60 brings out futures sellers -- the companies trying to stay alive -- and the market stays strong on year-over-year comparisons revolving around consumer spending.

I think 10% down is the real sweet spot for that $2-a-gallon figure that's got us revved, and that's the likely price given the pace of the economy vs. the huge production still coming on from Texas and the Gulf of Mexico.

Get an email alert each time I write an article for Real Money. Click the "+Follow" next to my byline to this article.

Action Alerts PLUS, which Cramer co-manages as a charitable trust, has no positions in the stocks mentioned.

TAGS: Investing | U.S. Equity | Energy | Stocks

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