Crude Oil Drifts Toward The Top End Of Its Trading Range

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So far, in 2019, the price of nearby NYMEX crude oil futures traded from a low at $44.35 in January to a high at $66.60 in April. At $57.25 per barrel on November 8, the price of the energy commodity was just above the midpoint of the year. Nearby Brent crude oil futures traded in a range from $52.50 to $75.59 per barrel in 2019. At a price of $62.40 on November 8, the price of the Brent benchmark was just below the midpoint for this year.

Since early October, December NYMEX futures have moved from $50.89 to $57.88 per barrel as the price has drifted from the bottom towards the top end of its trading range. The path of least resistance for the price of the energy commodity can be like a jigsaw puzzle. Supply and demand for petroleum, macroeconomic forces, and political events are all moving parts that influence the price of crude oil. Bullish and bearish factors have been pulling the energy commodity in opposite directions. The attack on Saudi oilfields caused a spike to the upside in mid-September. The trade war between the US and China has weighed on global economic growth and the price of crude oil. As we move towards the end of the year, optimism over trade and relative calm in the Middle East have switched places to present a confusing landscape for the oil market.

Buying dips and selling rallies in the crude oil futures arena has been the optimal approach to the energy commodity. I continue to favor the double leveraged ProShares Ultra Bloomberg Crude oil product (UCO) and its bearish counterpart (SCO) to capture the ups and downs in the world of oil.

Sitting and waiting

The crude oil futures market on NYMEX has been moving higher and lower, but it has gone nowhere fast.

Source: CQG

The weekly chart of nearby WTI crude oil futures highlights the tight trading range since May. Aside from a spike to $63.38 on the back of the drone attack on Saudi oilfields, the price has traded from $50.52 to $60.94. Price momentum and relative strength indicators are on either side of neutral. Open interest, the total number of open long and short positions has remained mostly below the 2.15 million contract level. The record high in the metric was at around 2.65 million contracts in early 2018. At 28.57%, weekly historical volatility was just below the midpoint of the year.

The technical picture reflects the bullish and bearish factors that have pulled the energy commodity in opposite directions.

A rally despite bearish inventories

The price of nearby NYMEX futures settled at $56.23 per barrel on Friday, November 1. At the end of last week, they were trading above the $57 per barrel level even though the latest inventory data from the American Petroleum Institute and Energy Information Administration for the week ending on November 1 was bearish.

The API told markets that that oil stockpiles rose by 4.26 million barrels while the EIA reported an increase of 7.9 million barrels last week. Both agencies reported a decline in product inventories. The API said gasoline stocks fell by 4.0 million barrels and distillates declined by 1.6 million barrels as of the first day of November. The EIA reported that gasoline and distillate inventories dropped by 2.8 million and 600,000 barrels, respectively. The data was not supportive of higher prices for oil, but the price of the energy commodity moved higher in the aftermath of the data releases.

Trade trumps inventories

One of the primary factors weighing on the price of crude oil had been the fears of a global recession as the trade war between the US and China weighed on the Chinese economy. The most recent economic data from the world’s second-leading economy has signaled a continuation of the slowdown.

Last week, the two sides made progress towards a “phase one” agreement on trade. It appears that China and the US will suspend any new tariffs scheduled for the coming weeks and that China will proceed with purchases of US agricultural products. One of the issues that could have triggered the positive news on trade was that China has cracked down on the drug business. US President Trump has demanded that the Chinese government cracks down on the flow of fentanyl into the US from China to stem the opioid crisis. On Thursday, China publicly sentenced one fentanyl trafficker to death and others to life in prison. The move likely paved a path towards compromise from the US. A deal benefits the Chinese economy. At the same time, a “phase one” agreement is a victory for President Trump as one of his campaign promises was to level the playing field on trade with China.

The prospects for economic growth on the back of a de-escalation of the trade war caused industrial commodity prices to rally on Thursday, November 7, The price of copper moved above the $2.70 per pound level, to a new short-term high at $2.73 before sliding back below $2.70 at the end of the week.

Source: CQG

The chart shows that the price of January NYMEX crude oil futures moved over $1 per barrel higher on November 7 to a new marginal high at $57.88 per barrel.

OPEC meeting on the horizon, and so is an Aramco IPO

Another factor that could be supporting the price of oil is that the biannual meeting of the international oil cartel is now less than one month away. The oil ministers of OPEC will gather in Vienna, Austria, on December 5 and 6. On the first day of the meeting, the members will discuss production policy for the first half of 2020, but on the second day, Russia will join the cartel. A final decision on production quotas will likely come on December 6.

Russia has become an influential non-member of the cartel since 2016. The Russians have participated in production cuts. Russia’s oil minister Alexander Novak takes his marching orders directly from President Vladimir Putin. Russia continues to extend its sphere of influence in the Middle East. Participation and guidance in OPEC decisions have been a central strategy for the Russians for more than three years.

In the days before the last OPEC meeting in early July, the Saudi oil minister told the world that his nation’s desired range for the price of crude oil is $60-$70 per barrel on Brent futures.

Source: ICE/RMB

The chart shows that the range in Brent crude oil since early July has been from $55.88 to $71.00 per barrel. The price spike to $1 above the top end of the Saudi’s desired range came after the attack on their oilfields in mid-September. Meanwhile, the price of Brent crude oil had spent most of its time at or below the $60 level aside from the price spike since the last OPEC meeting.

The members of OPEC extended the 1.2 million barrel per day production cut into 2020 at the early July meeting. Given the price action over the past five months, the cartel could consider a deeper cut to prop up the price of the energy commodity. The Russians and Saudis are competing with the US, which now leads the world with 12.6 million barrels per day of production. The previous strategy of flooding the market with oil to chase US producers out of the market did not work, so further production cuts could be on the horizon.

Ironically, Saudi Arabia needs a higher oil price to diversify its economy away from dependence on revenues from the energy commodity. Over the recent weeks, the plans for an IPO of Saudi’s state oil company Aramco has moved back into the limelight. The previous attempt fell apart over differences between Saudi expectations of valuation compared to those offered by financial institutions around the world. Crown Prince Mohammed bin Salman believes Aramco should receive a $2 trillion market cap or higher as it is the world’s most profitable company. Many banks and other financial institutions thought that the value was at or below the $1.5 trillion level. The plans to sell 5% of the company would raise capital for the Saudi sovereign wealth fund to diversify the nation’s future away from oil revenues. Time will tell if an Aramco IPO ever makes it to the market. However, the October 2018 murder of Jamal Khashoggi and the recent drone attack on Aramco production are factors that would weigh on the company’s valuation and investor interest in an IPO.

Meanwhile, if the Saudis are planning to proceed with the offering, they have a significant interest in a higher oil price in 2020, which could lead to a deeper production cut at the early December OPEC meeting.

One year until the energy election – UCO and SCO for those who do not trade futures

Another factor that could influence the price of crude oil over the coming year is the US Presidential election. President Trump has been a champion of energy independence. Regulatory reforms under his administration have turbocharged production of both oil and natural gas making the US the world’s leader in the output of both energy commodities. However, the progressive wing of the opposition party supports the “Green New Deal,” an initiative that would reduce the production of fossil fuels. Senator Elizabeth Warren, one of the leading progressive candidates to challenge President Trump, pledged to end fracking on day-one of her administration. An end to fracking in the US could lift the prices of oil and gas as it would hand power back to OPEC and the Russian when it comes to controlling energy prices around the world.

On the other hand, President Trump has not only increased oil and gas output with his policies; he has been an advocate for lower energy prices with consistent warnings to OPEC and Saudi Arabia when the price of oil rises. During the most recent attack on Saudi Arabia, the US President said he stood ready to release oil from the US SPR to prevent prices from moving sharply higher.

Positive news on trade lifted the price of crude oil to the top end of its trading range late last week. However, bullish and bearish factors continue to pull the price of the energy commodity in opposite directions. Any disappointment on the trade front could quickly send oil back towards $50 per barrel, while tensions with Iran in the Middle East continue to underpin the price.

I remain cautiously bullish on the price of oil. I have been trading the energy commodity from the long side, with tight stops.

The most direct route for a risk position in the oil market is via the futures and futures options that trade on NYMEX for WTI and the Intercontinental Exchange for Brent. For those who do not venture into the futures arena, the double leveraged ProShares Ultra Bloomberg Crude oil product and its bearish counterpart SCO provide an alternative to the NYMEX futures.

The most recent top holdings of UCO include:

Source: Yahoo Finance

UCO holds futures and swaps positions to create double leverage on the upside in crude oil, while SCO does the same on the downside. UCO has net assets of $334.51 million, trades an average of over 3.7 million shares each day, and charges an expense ratio of 0.95%.

SCO has net assets of $75.18 million, trades an average of 2.6 million shares daily, and charges the same 0.95% expense ratio.

The price of December crude oil futures rose from $50.89 on October 3 to a high at $57.88 on November 7, a rise of 13.74%.

Source: Barchart

Over the same period, UCO has rallied from $14.28 to $18.39 per share or 28.78% as it delivered slightly over twice the percentage return as the December crude oil futures. Both UCO and SCO do an excellent job providing double leverage in the WTI crude oil market, but they are only appropriate for short or medium-term risk positions. The leverage involved time decay, which eats away at the value of both products in the long term.

Crude oil is drifting towards the top end of its trading range. A trade deal between the US and China is bullish. Inventories and US production continue to weigh on the price of oil, but Iran and the upcoming OPEC meeting could provide support. And, the 2020 Presidential election could cause the price of oil to move higher and lower with the political polls. UCO and SCO are trading tools for those who do not venture into the oil market, which promises to continue to offer opportunities for nimble traders with their fingers on the pulse of the energy commodity.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.