Crude Oil: Is the end of the party in sight?

Crude oil & gasoline futures fell sharply yesterday after a report showed U.S. consumer confidence dropped to the lowest level since October 1992.

The average U.S. gasoline pump price reached an all-time high May 26, crimping demand from motorists.

"The litmus test over the next couple of weeks will be how the U.S. driving season pans out and it looks like the risk is to the downside," said Mark Pervan, the senior commodity strategist at Australia & New Zealand Banking Group Ltd. in Melbourne. "The market is saying the driving season is going to disappoint."

Yesterday, oil dropped more than $3 a barrel in the biggest one-day drop since April 29 to close at $128.85. Futures reached $135.09 on May 22, the highest since trading began in 1983, and have doubled in the past year.

"People realize that there is a point where high prices are going to start affecting demand and consumers will start revolting," said Anthony Nunan, assistant general manager for risk management at Mitsubishi Corp. in Tokyo. "The market is easy to push up until we have a collapse in demand and that's what it's going to take to get this thing into a downtrend."

Early yesterday prices had rallied on reports that Valero shut the 55,000 barrel per day gasoline-making fluid catalytic cracker at its 160,000 barrel per day refinery Paulsboro, New Jersey (near Philadelphia), due to a leak in an expansion joint. While we were unable to conclude when the gasoline unit will be back running, one our sources, a refinery engineer, said this type of problem is easily remedied, which means it should be back running this week.

Valero did report problems at its Caribbean refinery in Aruba, but it was reportedly minor.

As the news was digested in the marketplace, it became clear that the refinery snags are all minor and won't have any real impact on summer grade gasoline, and even gasoline succumbed to the liquidation impacting heating oil and crude oil.

However, it is still too early to declare prices have peaked as we remain confident the perennial bulls still intend to reach new record levels, said Oilintel."As we wrote recently our technical analysis suggests that until crude oil falls below $110.30 and stays there, prices have a better chance of trying to set new highs."

It should be noted that Tuesday's refinery rumour would normally have pushed prices much higher as the bulls normally seize any news of a bullish nature as justification to buy heavily. This was not the case.

More of a signal is watching the shrinking contango, or higher forward prices. As these margins shrink, it will be more of a sign that perhaps major long positions are under pressure as the publicity surrounding the impact of speculation in the market grows.

More and more critics of commodities trading are criticizing the huge long positions held by hedge funds, implying they have artificially inflated prices. Also, there has been long overdue criticism of the type of forecasts that Goldman Sachs and others announce, which serve to feed the frenzy and further artificially inflate prices.

At some point, there will be widespread acknowledgement that what we have here is a classic bubble.