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Page added on May 13, 2017

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Crude Oil: Flip A Coin

Consumption

Summary

With confirmed break above $49/bbl (“heads”), crude will likely resume its uptrend.

With confirmed break below $47/bbl (“tails”), crude will likely begin a new downtrend.

In the short run, supply and demand is a mere headline and has little effect on price direction.

Introduction

Last week, we outlined a bearish case for crude oil and the United States Oil Fund (NYSEARCA:USO). After a surprisingly bullish EIA report on Wednesday following only a mildly bullish API report on Tuesday evening, we have updated our near-term outlook to a coin flip. After the EIA report, we covered our short position and went long at $47/bbl and selling yesterday when the market appeared to be drifting back below $48/bbl.

We have shifted back to a long bias, based upon a belief that OPEC and other market makers have a vested interested in keeping the oil price higher, not only for the Saudi Aramco IPO scheduled for 2018, but also for the financial health of oil exporting countries worldwide. We have covered these issues in prior articles.

On the other hand, the market has been oversupplied with oil for more than two years. While there have been glimmers of hope for supply-demand re-balancing, oil supplies in the U.S. remain at all-time monthly highs. If the price of oil was in the $20s at lower inventory levels, who is to say that it cannot return there?

The USO ETF closely follows the front-month WTI crude oil futures contract on NYMEX, since it holds the front-month futures contracts as its primary asset. USO can be useful for short-term trading positions, but is not always a great candidate for “buy and hold” investors, due to time decay created by the normal structure of the futures market. We covered that briefly in an article that can be accessed here. We have updated our indicators for USO investment, and the above table summarizes our current outlook.

USO recently completed its monthly roll over from the June to the July crude oil futures contract. If you are investing with USO, the current ratio of July NYMEX contract to the USO price is about 4.80, so $48/bbl equals $10/share for USO.

Technicals

We believe that technical analysis on the continuous West Texas Intermediate Crude Oil futures contract is more relevant than technical analysis on USO. Therefore, while our charting below is on the oil futures contract traded on NYMEX, our trading positions are often on USO, which is very liquid and accessible. On the crude oil daily chart, we highlight a few items:

  1. The bullish EIA report has reversed the bearish technical picture. Recovery of price above $47/bbl and $48/bbl, at a minimum, have created some short covering. It is possible that this week’s rally has been a short-covering rally.
  2. Resistance above the price includes the prior uptrend line near $48.5/bbl and the 200 day SMA at $49.0/bbl. If price rallies above $49/bbl and the 200 day SMA, it may have technical energy combined with geopolitical forces to regain the current uptrend.
  3. If price breaks below $47/bbl, $45/bbl and the and the newly established lows, then the technical momentum would combine with the reality of an over-supplied market to confirm a new downtrend. Since late February, the chart shows lower highs and lower lows.
  4. Perhaps another scenario here is that crude oil trades sideways in a broadening range set by $47/bbl and the rising prior uptrend line.
  5. In all cases, price may temporarily breach support and resistance temporarily to run stops. Crude oil is at a watershed level, particularly near the very psychologically important $50/bbl level.

Geopolitics

In our most recent updates, we laid out our view that Saudi Aramco’s planned initial public offering in 2018 should provide (direct and indirect) support to crude oil prices.

Oil price will continue to respond to headlines from OPEC members, and we should expect that OPEC member nations will respond to any price decline with headline creating bullish comments.

Currency and Refined Products

Crude oil has value due to the refined products that are produced from it: diesel and gasoline. Since Canada’s GDP is heavily reliant on crude oil, the value of the Canadian dollar tends to move along with the price of crude oil, and vice versa.

Below, we have graphed the price of crude oil (in candlesticks) versus the relative value of refined products (black line) and the CADUSD (blue line). We view the combination of these relationships as cautionary. Further weakness in the CADUSD pair will weigh on the price of crude oil and USO.

Supply and Demand Fundamentals

The U.S. remains at or near record highs for crude oil, gasoline and diesel fuel. We have copied below a helpful summary of the current and historical supply and demand picture, which was produced by Ole Hansen, a commodity analyst with Saxo Bank. The total crude oil inventories in the U.S. are in the upper left corner. Total inventories are less than record highs, but highest ever for the current calendar week.

The crude oil market has been oversupplied for many months, so the fact of oversupply is not the primary determinant for near-term price direction. In the short run, headlines and technical factors will dominate price direction.

Thanks for any comments and feedback below. If you liked this article, please hit the follow button above.

Note: All charts above were taken from TradingView. Unless otherwise indicated, the tables were created by Viking Analytics.

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3 Comments on "Crude Oil: Flip A Coin"

  1. rockman on Sat, 13th May 2017 9:28 am 

    “Summary With confirmed break above $49/bbl” And once more that rediculous claim. So again, as explained many times, there is no one price at which wells in any trend (conventional or unconventional) are economic to drill. There are Eagle Ford Shale prospects that would be profitable at $35/bbl and others that wouldn’t be drilled at $75/bbl. Every potential prospect undergoes a detailed economic analysis with most companies using the current oil price. The calculation uses the completed well cost estimate and the potential production profile. That generates the rate of return and the payout period (how many months for net income to recover 100% of the well cost).

    Those are the two metrics that dominate drilling decisions. And since both the oil price and well costs are static at the time of analysis the only significant variable is the prospect’s reserves and production rate profile.

    Not anymore complicated then that: regardless of a higher or lower oil price only prospects that recover adequate reserves AND does so at a fast enough rate yield an acceptable ROR.

    So let’s focus on the production rate. Example: two wells cost exactly the same and recover exactly the same amount of oil. But Well A recovers those reserves in 5 years and Well B in 9 years. Thus the ROR of A is higher then B which does not reach an acceptable level.

    IOW two wells with identical URR costing exactly same and only one gets drilled. But this also explain how unconventional wells have an advantage over some conventional prospects: that unusually high initial flow rate. The ROR is very prejudiced by the early high flow rate. IOW it significantly increases the ROR. This helps to offset the high cost of long hz wells with numerous frac stages.

    But the downside as most should understand by now is the high decline rate. As a result a good shake well might reach it first payout in 12 months and thus yield a very good ROR. But it may take 4+ years to recover 100% of its cost a second time. A conventional well that pays out in 12 months might any take 16 months to reach its second payout and then another 20 months to reach its third payout.

    And thus why the shale payers need to drill as many wells as fast as possible to increase the company’s total revenue stream.

    A long explanation but if you hung in there you should now understand why the “break even price” doesn’t have a f*cking thing to do with the amount of unconventional drilling that takes place.

  2. bobinget on Sat, 13th May 2017 12:00 pm 

    It’s my contention, Geopolitics, exerting more pressure on crude than ‘supply and demand’.

    1) Nothing is wrong with US demand. (fact)

    2) Libya getting back on line is more or less meaningless until Libyans establish a solid dictatorship. Like drug lords, dozens of militias will still fight over ‘the take’ and ‘territory’. So far, no strongman.

    3) Until #1 crude importer, China, shows a little ankle of transparency, we know half a consumption story.

    4) Nigerian oil workers on strike. Oil workers in Nigeria
    (and Venezuela) can’t feed families if they aren’t paid.
    Nigerian inflation 17.5%.. Venezuelan, between 500% and 600%.

    5) All sides seem determined to bring Venezuelan
    government to it’s knees by forcing crude ever lower.

    If Ven’s crude production ends, 900,000 BB per day, off market. When— this happens, “the tide goes out, we will see who is wearing a bathing suit”. W. Buffett

  3. bobinget on Mon, 15th May 2017 9:34 pm 

    By: PanARMENIAN.Net

    Source: PanARMENIAN.Net

    Washington is working to push through contracts for tens of billions of dollars in arms sales to Saudi Arabia, some new, others in the pipeline, ahead of U.S. President Donald Trump’s trip to the kingdom this month, people familiar with the talks told Reuters this week.

    Saudi Arabia is Trump’s first stop on his maiden international trip, a sign of his intent to reinforce ties with a top regional ally.

    The United States has been the main supplier for most Saudi military needs, from F-15 fighter jets to command and control systems worth tens of billions of dollars in recent years. Trump has vowed to stimulate the U.S. economy by boosting manufacturing jobs.

    Washington and Riyadh are eager to improve relations strained under President Barack Obama in part because of his championing of a nuclear deal with Saudi foe Iran.

    Lockheed Martin Co (LMT.N) programs in the package include a Terminal High Altitude Area Defense (THAAD) missile defense system with several batteries, the sources said. The THAAD system, like the one being made operational in South Korea, costs about $1 billion. Also being negotiated is a C2BMC software system for battle command and control and communications as well as a package of satellite capabilities, both provided by Lockheed.

    Combat vehicles made by BAE Systems PLC (BAES.L), including the Bradley Fighting Vehicle and M109 artillery vehicle, are also under consideration as part of the Saudi package, people familiar with the talks said. Both vehicles are in the Saudi inventory. British defense company BAE has 29,000 employees in the United States.

    The sources spoke on condition of anonymity because they were not authorized to discuss the negotiations, which also include previously reported contracts or items under discussion for years. One such deal, an $11.5 billion package of four multi-mission surface combatant ships and accompanying services and spares, was approved by the State Department in 2015. Talks followed to hammer out capabilities, configuration and design for the complex warships but the deal has never gone to final contract.

    The next step for the ships is likely a letter of agreement between the two countries, the sources said.

    Versions of the ship used by the U.S. Navy, the Littoral Combat Ship, are built by Bethesda, Maryland-based weapons maker Lockheed Martin and Australia’s Austal Ltd (ASB.AX). If a deal goes through, it would be the first sale of a new small surface warship to a foreign power in decades. Any major foreign weapons sale is subject to oversight by Congress. Lawmakers must take into consideration a legal requirement that Israel must maintain its qualitative military edge over its neighbors.

    Also, more than $1 billion worth of munitions including armor-piercing Penetrator Warheads and Paveway laser-guided bombs made by Raytheon Co (RTN.N) are in the package, the sources said. The Obama administration suspended the planned sale because of concerns over the Saudi-led military campaign in Yemen and civilian casualties.

    A U.S. administration official said the proposed Raytheon sale was still undergoing interagency review. Representatives for BAE and Raytheon declined to comment on the sales. A Lockheed representative said such sales are government-to-government decisions and the status of any potential discussions can be best addressed by the U.S. government.

    A representative for the Saudi embassy in Washington declined to comment.

    Shares of both Raytheon and Lockheed closed up 0.9 percent. Both stocks hit session highs following the Reuters report.

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