Oil prices and aggregate demand

Oil closed out the month on a down slope, tumbling on the strengthening of the dollar and a weaker outlook for equities. On a larger scale, the story with oil over the part 3 months or so has been the larger macro forces completely overwhelming the oil-specific supply and demand issues. For example, the market has largely been unresponsive to OPEC's desperate attempts to prop up oil prices; currently, it's estimated to be running under capacity by ~6MM barrels. A lot of oil traders believe that OPEC won't be able to hold themselves to their production cuts and the rest believe that the macro-imposed demand constraints are a much stronger force. As an example of these macro demand shocks, it would be good to look at our posts on Japanese demand and dry shipping.

ZH believes that the oil market is following the lead of the other major markets and is overestimating the probability of a recovery in a relatively current timeframe. Here is the May 09 West Texas crude contract over the past month:

Given the basis on oil has been pretty negligible recently, this is a good contract to track. Going forward, oil is going to continue to be driven by the strength of the dollar and the short term outlook for equities. As we believe that we aren't anywhere close to being out of the woods, it's unlikely for spot oil and near contracts to go much higher than the $55 level.

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