Oil Prices Jumped Up but Don’t Get Too Excited

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Oil barrels with price graph
Oil barrels with price graph
Oil barrel on the background graphics prices. The rise in price and cheaper petroleum.

Last Friday, the price of global petroleum jumped up by 8%. This performance was good enough to trim oil commodity losses for the month of January to 9%. Many investors who are betting long on oil would think that this is great news. After all, the main trigger for oil’s late rally was the latest count of US oil rigs in operation. There’s been a big drop in the number of oil rig operation in the United States. It doesn’t look like the downward trend is going to change anytime soon.

For every oil rig taken out of commission, the supply of oil is generally understood to go down. Unfortunately, this straight mathematical commonsensical thinking doesn’t really match the reality. Sure, oil rig counts have been going down but the total amount of oil being produced is actually increasing. What gives? Very simple. Improved extraction technology. Modern American oil extractors are extremely efficient and very much driven by productivity concerns. Even if you mothball oil rigs at an increasing pace, a lot of those oil rigs are probably located in not so profitable oil fields in the United States to begin with. There are many shale oil fields that are very expensive to operate in. It’s no surprise that the oil rigs based on those locations would get idled. However, don’t make the mistake of assuming that just because all these oil rigs are no longer in operation that the global supply will go down. Thanks to extraction efficiency, expect supply to keep pushing upwards.

Another key reason why oil jumped up 8% is the fact that many traders who are betting on oil to keep crashing had to cover their short sale positions. Whenever enough investors cover short sales, this triggers an appreciation of the price of the stock or commodity being shorted. This shadow appreciation doesn’t really reflect the real health of the underlying stock or commodity.

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