Bears still in charge as oil plunges to $40

So much for that nascent oil rally. In this oil market, the bears rule. True, the bulls have their moments, but these are fleeting, like that proverbial church mouse that sneaks out for a peak from time to time, only to be chased back into its hole by the parish cat.

Oil's free fall resumed in earnest Monday, as the world's most important commodity plummeted $4.27 to $40.45 per barrel on renewed concern that a prolonged recession in the U.S. and internationally will reduce oil demand.

What spooked the oil trading pits Monday? The European Union's rejection of pleas by Eastern European nations for an aid package totaling more than $200 billion, which fanned concerns of rising bank and company defaults in the east, with ripple effects in Europe and the United States. Traders were also discouraged by February ISM manufacturing data, which showed a U.S. manufacturing sector contracting for the 13th straight month.

"The consensus is that OPEC will need to make another cut," Gareth Lewis-Davies, Dresdner Keinwort analyst, told Bloomberg News Monday. "It is needed in the sense it gives a signal of intent by OPEC to manage global oil supplies. OPEC creates expectations in the mind of market participants."

Oil bears take no prisoners

And as has been the case since oil's halcyon days ended last summer, the oil bears took no prisoners in the major energy commodities categories Monday. Heating oil fell 8 cents to $1.18 per gallon, unleaded gasoline decreased 6 cents to $1.31 cents per gallon, and natural gas declined 10 cents to $4.30 per million BTUs.

For consumers, oil's price decline means gasoline prices won't rise as much as they historically do in the spring, the start of the summer driving season in the United States. Further, the bearish oil market will provide some relief late in the heating season for residents and businesses who use oil to heat homes and businesses.

The declines will also serve as a de-facto tax cut for American motorists. Each $1 per barrel drop in oil increases U.S. GDP by $100 billion per year and every 1 cent decline in gasoline increases U.S. consumer disposable income by $600 million per year.

For investors, declining oil prices are net-negative for the oil sector, including integrated oil companies and related energy plays, such as companies who build and maintain oil rigs and the energy infrastructure. But the declining price is a plus for most other companies including the major airlines and delivery companies. The major airlines particularly love low oil prices, as jet fuel is typically their second or top operating expense.

Economic Analysis: As noted, while net-negative for U.S. integrated oil companies, low oil and gasoline prices serve to stimulate the U.S. economy -- something that would hasten the recovery in corporate revenue and earnings, and stock prices, if oil prices remain low for six to nine months.

How low could oil go? Given current U.S. economic fundamentals, oil will likely test the $30-range in the months ahead, barring a sudden reversal in the economy, which is not likely. OPEC is likely to cut production when it meets next in March, but they would need to cut by 2.0 million barrels per day (bpd) to stabilize prices -- without production cheating; they'll probably cut just 1.25-1.5 million bpd. Further, since $30 represents a key, psychological support level for oil, moves below that will require continued negative economic sentiment.
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