A Reversal For Oil?

by .
Alistair Meadows
Alistair Meadows

Things move very quickly in commodity markets- in April 2020, one literally could not give away oil (at one point it COST $40 to get rid of the stuff), but by May 2022, it was at $130 and seemingly set to reach the moon. Fast forward to today and Crude Oil has fallen nearly 30% in just two months and, as of the 17th August, is down again, to around $87 per barrel.

We appear to have arrived at a situation whereby downside momentum is taking on a life of its own, (selling begetting more selling).

Oil futures speculators have now reduced their net long positions to close to that of March 2020 (long 135,000 contracts), less than half of those held at the end of June 2022 (374,000). [As stated above, soon after this long liquidation, markets went sharply up].

Crude Oil COT Aug 2022

Adding interest to this situation, Producers have, since June 2022, nearly doubled their net long exposure to 98,000 contracts -when Producers and Speculators disagree so violently, it is usually the latter that are wrong.

The question is what could prompt another reversal in what is now conventional wisdom, namely that prices can only go lower from here?

Price Drivers

One of the drivers for this decline has been speculation of a rapprochement between the US and Iran over the latter’s’ nuclear ambitions.

If agreement is reached, Iranian oil can once again be freely traded in global markets, thus lowering prices.

But with the Iranians and the Russians getting increasingly close on both nuclear weapons development (as they clearly have a common enemy) and in energy policy. They have little incentive to compromise with the West and thus the deal will likely stall at best, leaving oil demand still ahead of supply, as winter approaches in the Western world.

We can already see the likely effect on heating costs in the UK, but European electricity and gas prices are rising even faster in Germany; it could get much worse by January.

More broadly, the measure of monetary policy (Financial Conditions) which tries to define how restrictive monetary policy actually is within the US economy has effectively erased most of the Feds interest rate rises, via higher equity prices and lower bond yields, meaning that Oil demand will likely rise again once the current sell off gets into extreme territory, (which it may well be now).

Latest US EIA (Energy Information Administration) reports suggest that overall oil demand remains firm, despite recessionary concerns; in particular, gasoline demand is very strong.

Crude Oil WTI Oct 22

Trade Ideas

Key support appears to be around the $84.50 level, so stops need to be paced $2-$3 below that point.

The nature of the last 3 days’ rise looks corrective, implying another decline, possibly to below recent $85.40 lows.

If so, one has a close stop and a low risk entry point at which to go long. Selling an up-side call at the same time as buying the Future (an October 91 call for example -currently 375 bid) would also lower overall risks.

Prior to expiry of the option (16th September), upside profit would be $4.78 (assuming a future price of $90 to open). Once expiry is over, one would then sell further call options (for November) to “lock in” any positive returns.