Bullish and bearish factors are at play in the crude oil market these days, and the price has stalled at just under the $60 per barrel level on nearby NYMEX August futures. Before the recent OPEC biannual meeting, the Saudi oil minister said that the sweet spot for Brent is between $60 and $70 per barrel, so at around $67, Brent is sitting at a level that is satisfactory for the most influential member of the cartel.
While the price action in the energy commodity has been less than exciting since it recovered from the most recent price correction, there are reasons why market participants should not become too complacent. Growing US production weighs on the price, but the cartel’s extension of output quotas was a move to provide some balance to the market and maintain some degree of influence for OPEC. Meanwhile, the most substantial factor facing the oil market is the ongoing tension in the Middle East. With sanctions tightening the economic noose around the neck of the theocracy in Teheran, the potential for events that could cause at least a short-term price spike in the energy commodity remains high.
I am more comfortable trading crude oil from the long side of the market these days, and given the tightening trading range, the futures markets and the ProShares Ultra Bloomberg Crude Oil product (UCO) are the tools I am using to buy dips and take profits on rallies in the energy commodity.
A trading range, but trending higher
Crude oil has been in a trading range between $66.60 and $50.60 since mid-January. The most recent high came in late April, but concerns surrounding the global economy and demand for the energy commodity took the price to the low in early June.
As the weekly chart highlights, both price momentum and relative strength indices were in neutral territory at the end of last week. While open interest, the total number of open long and short positions in the NYMEX crude oil futures contracts has been on either side of the two million contract level throughout 2019, weekly historical volatility has increased since May from under 16% to almost 38%. Wider daily price ranges have increased trading opportunities in the crude oil futures market. Since early June, the price of crude oil has been trending higher.
The Brent-WTI spread edges lower after OPEC’s latest news
At the most recent biannual meeting of the international oil cartel on June 1 and 2, OPEC extended the 1.2 million barrel per day production cut into 2020 as concerns over the trade dispute between the US and China has weighed on the demand for energy. The continuation of the production cut and US output at 12.3 million barrels per day according to the latest data from the Energy Information Administration have weighed on the Brent-WTI spread. Brent is the pricing benchmark for two-thirds of the world’s oil production, including the output from OPEC members.
The daily chart of the price of WTI NYMEX crude oil futures minus Brent futures shows that the premium for Brent declined from $8.71 on May 28 to $6.42 per barrel on July 12. On the continuous contract, the Brent premium fell from a high at $11.59 per barrel at the end of May to the current level.
While the Brent-WTI is a barometer of political risk in the Middle East, the OPEC quotas and record production from the US have caused the Brent premium to decline since late May. Meanwhile, since the Arab Spring in 2010, a decline in the Brent premium over WTI has typically caused the price of oil to move lower. While a correction occurred that took the price of oil to $50.60 in early June, since then, as the Brent premium declined the price of crude oil has moved to the upside.
Inventories have been bullish over the recent weeks
Over the past four weeks, inventory data from both the Energy Information Administration (EIA) and the American Petroleum Institute (API) have supported gains in the price of crude oil. Four consecutive weeks of declines in crude oil stockpiles have taken the price of crude oil futures to over the $60 per barrel level on WTI nearby futures and over $67 per barrel on Brent futures. As of the week ending on June 14, the EIA and API reported respective declines of 3.1 million barrels and 812,000 barrels. For the following week, the decreases in stockpiles were 12.8 million and 7.55 million barrels. The week of June 28 brought a drop in stocks 1.1 million and 5.0 million barrels. The most recent data from the EIA told the market that as of the week ending on July 5, inventories declined by 9.5 million and the EIA reported a drop of 8.129 million barrels.
Despite the ongoing trade dispute, falling stockpiles have sent the price of crude oil higher over the past month. Over the past three weeks, the draws from inventories have been higher than the market had expected.
The problems with Iran will only get worse
The other factor that continues to underpin the price of crude oil is the growing tension in the Middle East. Iran has not taken economic sanctions without retaliation. Iran has attacked oil tankers over recent months. Missiles aimed at Saudi Arabian production infrastructure and civilian targets have flown over the border from Yemen. Iran downed a US drone near the Strait of Hormuz. Last week’s attempt to interfere with a British oil tanker was another example of the increasing number of incidents in the region that is home to more than half of the world’s oil reserves.
At the same time, Iran has begun enriching uranium past the limits stated in the nuclear non-proliferation agreement from 2015 after the US walked away from the deal in 2018. The rhetoric between Washington and Teheran has been increasing, and the military presence in the Middle East has grown. The bottom line is that any hostilities that impact production, refining, or logistical routes in the world’s most politically turbulent area will only increase supply concerns and could cause price spikes to the upside in the oil futures market when it comes to both Brent and WTI futures.
The Middle East continues to be the leading factor providing support for the price of crude oil. Iran is not likely to back down over the coming weeks and months. The Islamic Revolution and chants of “death to America” and the hatred of Israel and the west have been a constant since the late 1970s. Even in the wake of the nuclear non-proliferation agreement in 2015, the chants, rhetoric, and support for terrorist groups in the Middle East continued which is the reason why President Trump walked away from what he called a bad deal.
Trading oil from the long side with UCO – call options for a potential spike
The recent price drop in the crude oil futures market was an opportunity. It is possible that ongoing concerns over the trade dispute, weak economies in Europe and China, and increasing US crude oil output will cause another corrective move from the current level at just over $60 per barrel on the August NYMEX futures contract at the end of last week. I will continue to trade crude oil from the long side of the market with tight stops. I will only enter long positions during periods of price weakness. The most direct route for a long position in crude oil is via the futures and futures options for WTI and Brent crude oil provided by the NYMEX division of the CME and the Intercontinental Exchange. For those who do not venture into the futures arena, the ProShares Ultra Bloomberg Crude Oil product is a leveraged tool that replicates the upside price action in the energy commodity. The fund summary for UCO states:
The investment seeks daily investment results, before fees and expenses, that correspond to two times (2x) the daily performance of the Bloomberg WTI Crude Oil Subindex. The fund seeks to meet its investment objective by investing, under normal market conditions, in futures contracts for WTI sweet, light crude oil listed on the NYMEX, ICE Futures U.S. or other U.S. exchanges and listed options on such contracts. It will not invest directly in oil.
Source: Yahoo Finance
As the chart shows, over the same period UCO moved from $18.04 to $21.17 per share, a rise of 17.4%. UCO has net assets of $385.84 million, trades almost 3.4 million shares each day and charges an expense ratio of 0.95%. The liquid product is only appropriate for short to medium-term trades in the crude oil market on the long side. The double-leverage comes at a price, which is time decay over time. If the price of crude oil moves lower or trades in a narrow range, UCO will lose value quickly.
While bullish and bearish factors continue to pull the price of crude oil in opposite directions, I continue to believe that price weakness provides a compelling opportunity to purchase the energy commodity in the current environment. Moreover, the situation in the Middle East is a reminder that we should not become complacent when it comes to the potential for a price spike to the upside in the price of crude oil that can occur in the blink of an eye.
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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.