I know everyone is worried about bearishness in $SPX, and I will get into more of that issue in a later post, but I want to deal with what is the most confusing thing for most traders, investors, institutions, and followers of energy markets. I have read a ton of things, some of which forecast doom for oil markets, some (from even OPEC itself), that claim the “new and improved” oil supercycle has begun. Mr. Belski, who happens to be reticent on all the sanguine oil price forecasts, looks like a ball of stress in the video associated with the linked article. He is one more reason I am glad I am not in corporate America any more ).
The above image is something I dealt with a lot in my first 7 years as a professional. What many do not understand about oil in many cases is that in a waste emulsion (mixture), the oil trough it at the TOP because the cleaned oil is lighter than the water, solids, and salt. If you think that is confusing, then get a load of the WTI Crude oil futures market.
To cut to the chase, everyone has an idea about where WTI Crude Futures (CL #F) are going, but no one knows with any degree of certainty. What do the markets say about it? Again, lets get a MONTHLY chart and see the big picture. After that, I will drill down.
Points to study:
1) Look at the monthly chart. You will see that there are basically two support levels ( $40.49 and $37.00) and one primary resistance level ($52.00). That is very straightforward.
2) Look at the weekly chart. Note the seasonality of volume in almost every year. We do see some buying at the end of the gasoline peak, when crude oil prices soften. The difference this time ( at least in 2014 and 2015) is that buying accelerated in August as the Fed decided not to move to raise interest rates and that rig counts had plummeted based on monthly numbers compared to a year ago. What has yet to happen though is that prices have not yet moved above 49.33 ( as I mentioned in an earlier post as a forecast resistance level). Does that mean that it won’t go above it. NO. I think it is important to watch trading next week to see if the upward price momentum that is seems nascent in development follows through after traders and institutions study all of the recent supply data published by the EIA, which you can find here monthly. Demand could be picking up slightly, but supplies are still plentiful despite drops in inventory.
3) Look at the daily chart, otherwise known as the WTF (West Texas Fundamental ) Price Chart. Notice any solid trend to volume in price? I would say no, particularly as we got toward the end of last week. Friday we did see a little bit of reversal, but CFGMO (which I will attempt to reinstall on this chart package soon) is still not really showing a solid bullish reversal.
4) What is most interesting, however, is this table, which shows that crude oil forward months in futures contacts are showing forwardation, or an increase in crude oil prices in coming month via the futures prices. Note, however, that the increase is pretty slight going forward. In the current market, even traders willing to hedge currently will only take crude oil prices out until December 2023 at a price of $61.04/barrel for WTI Crude Oil. That can obviously change as events change, but for now, that is likely a reliable short term cap. This report on the same website provides the general reasoning for this, and it makes sense. With the dollar relatively strong amid our threats to increase interest rates and the relative (and I mean RELATIVE) strength of the US economy versus other world economies, there is continued pressure on oil prices via the U.S. Dollar which is the currency that crude oil is priced with. Other nations, Iran, Russia, and China, all are beginning to price their shipments in Euros, to break this monopoly, partly as a political hammer against our economy, and partly because they think over time that they can get fairer pricing for their exported energy. China in the future will consume much more energy than the rest of the world as its population modernizes. It would like to make the Yuan a world reserve currency to help support its consumer economy. Depending on how well, or how poorly, the United States manages to reduce and contain its massive government debt, the end results will at least be interesting to watch. If Russia succeeds in crushing ISIS (and it could), then Iran could pump oil at will (as could Iraq), supplies would increase and prices would FALL. If not, and disruptions from war occur, its anybody’s game.
What can you do now?
Let’s look one more time at the daily chart for targets.
As that article and this video tend to imply, the break-even price for oil shale development is somewhere around $60 a barrel. Until we see that, all one might expect is a rally to that resistance point (shown on the daily chart around 55.20) and it likely begins to drift until supply numbers and inventories adjust. If CL #F can remain above 43.71, then one might expect a slight rally to 55.20. If it breaks that level, then it is likely that we will retest the lows at 38.51. Until we see American foreign policy become coherent (if not at least sane), the Federal Reserve allow interest rates to seek some kind of normalized market price, and we figure out what OPEC thinks the window of pain for rebuilding rigs will be to allow them to raise prices, oil prices will CONTINUE to drift. That is what the futures traders think through forward charts, and that is what I think.
If it were me (and right now, it is NOT me):
If you want to guess that we have hit a bottom, you can take small positions in long WTI crude oil related instruments, but keep a tight rein on the stops below support. If you are right, you can add to them later. If you are wrong, GET OUT or make sure the position is hedged with options to ease the pain of the drop.
World events could create either a crushing rally or a crushing collapse, but the status quo sees a dull pain just below break-even in WTI Crude Oil prices and the cost of break-even drilling in places like the Bakken. A decent discussion of this situation can be found here.
If it were me, I would begin to watch US oil exploration stocks for improved earnings forecasts, but more importantly to watch for institutional buying volume in publications like Investors Business Daily. The same would go for U.S. integrated oil company stocks. It may be awhile before pricing and inventories favor new production and refining, and it is now possible, unless the world gets thrown into world war, that peak oil could no longer be the big worry we once thought it might be. There is still supply growth forecast though, and it will eventually make it into the pipeline and into refining. I would simply play the stocks where I could get some kind of indication that institutions were backing my long position after I had some some research about future prospects. I would also NOT buy huge initial positions. You would then cross into the realm of investing into the realm of “going to Vegas”. Do NOT go to Vegas, OK?
The true final analysis is simply this. Oil prices are operating in a 3-dimensional universe now where United States influence is and will be challenged in the future. Currency and interest rate issues are now up in the air (as the US Federal Reserve is backed against the wall with its zero-interest-rate policy). The United States is being openly challenged by China and Russia (if you haven’t figured out why Putin is now actively participating in eliminating ISIS, you should, and the same goes for China). If our interest rates rise, the dollar likely strengthens, and that puts pressure on these two major antagonists to get oil priced in something other than U.S. dollars. OPEC’s timeline for decreasing production is likely tied to the length of time it takes to completely disrupt drilling in the US. It has done a nice job of it, but it might be trying to extend the time for a US rebuild for three years or more. They know that demand is still building around the world, even under sub-optimal conditions of world GDP growth. All OPEC wants is the biggest share at the best price.
It would appear that the forward contracts reflect that reality for now, and the pricing is slightly BULLISH. Is it bullish enough to bet your house on a big rally? Probably not NOW, but one should begin to research the producers and watch the oil market demand side, and then watch institutional participation before making any large bets. You have to realize that this “oil super-cycle” is going to be a bit crazier than past ones. Its hard to steer a super-cycle when four entities are trying to pedal it. Its hard enough just to hold onto the handlebars, if you catch my drift.
As always, thanks for supporting this blog! I will shortly be adding widgets to this blog so you can share it. The ad spend to bring this thing is way too much at present to make it become a viable income producer in the short run, but I will build it slowly. When that time comes, I will do the survey, and build the infrastructure to bring the full power back to this blog with regard to equities, futures, and forex. I will even suffer the indignity of paying three times for data I only use once, once again.