Are Oil Prices Nearing a Bottom?

The recent decline in the price of oil has been among the swiftest ever. Crude prices have tumbled 22 percent so far this quarter, their steepest slide since the end of 2008, back in the deep, dark days of the financial crisis. Things are bad now for sure, with Europe on the brink and an underwhelming U.S. recovery. But are they Lehman Brothers, Bernie Madoff, AIG bad? Probably not. And there’s growing evidence that oil prices may be approaching a bottom.

Both domestic and international crude prices have risen over the past week. Since June 21, domestic West Texas Intermediate is up nearly 2 percent, while the price of international Brent is up 8 percent. That’s right about where they were during the last market bottom in early October. The seven-month buildup in U.S. oil supplies finally appears to be losing steam, after the Department of Energy reported that crude inventories fell 133,000 barrels last week (PDF). That’s not nearly as big a drop as many people expected—a Bloomberg survey forecast a 1.3 million-barrel decline. But it’s a drop nonetheless, and a rare one at that. Since December, U.S. oil inventories have risen 20 percent, yet over the past month the pace has flattened out. At 387 million barrels, the U.S. is still sitting on its highest supply of crude oil since July 1990.

The U.S. recovery also got a boost on Tuesday as the Commerce Department reported that May’s durable goods orders were better than expected.

The oil trade has also changed drastically in the last few months. After pouring billions of dollars into futures contracts from October through March, oil speculators have made a dash for the exits, taking with them the artificially high price of oil. Three months after the sell-off began, the amount of managed money betting that oil prices will rise is at its lowest level since September 2010. That could mark the beginning of a new buying cycle.

“Crude oil is no longer a crowded trade, so there is greater scope for a new cycle of buying to emerge,” says Tim Evans, an energy analyst at Citigroup. “The money is now on the sidelines and not in the market.”

For traders, oil at $80 a barrel (the current price of WTI) has significantly less downside risk than oil at $100. Barring some fundamental shock to the market that kills demand, there seems to be a natural equilibrium around $80 in the U.S. It’s high enough for producers to keep drilling and pumping, yet low enough that it shouldn’t curb consumer demand. At $3.43 a gallon, the average national price of gasoline in the U.S. is back to where it was in January.

That’s not to say a few risks aren’t out there that would lower the price of oil further. Europe is still an economic mess, and the reports leading up to this week’s EU summit in Brussels don’t offer much optimism. If the euro starts to crumble, oil prices will surely drop. China’s economy is slowing, faster perhaps than it’s letting on. And then there’s OPEC, which has significantly boosted production in recent months. Should Saudi Arabia continue to pump away at its fastest rate in more than 20 years, that will probably keep prices from rising too much.

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