Excess supply and low demand mean that crude oil could touch a low of $58
SEPTEMBER has been a good month for major oil exploration and production companies, with a number of giants such as BP and Tullow striking black gold in recent weeks, sending their share prices soaring. BP’s share price rose more than 4 per cent following the announcement, while Tullow saw a similar gain.
But while the oil majors have been celebrating their new finds – which should guarantee them a good few more years in business – oil bulls will have been disappointed by crude oil struggling to break out of the $60-$75 a barrel range that it has been trading in since the start of August.
While oil is far above its lows of $35 a barrel that it hit back in February, bulls will have been hoping that the stock market rally, a general return of risk appetite and signs of a real revival in manufacturing would push the price of a barrel even higher.
Although there have been plenty of signs suggesting that the recession is either over, or at the very least coming to an end, oil is failing to make gains for two reasons: oversupply and weak global demand.
Last week we saw the biggest two-day decline in crude prices, following data released by the US Energy Information Adminstration (EIA) which showed that in the week ending 18 September, gasoline supplied in the US – which is an implied gauge of consumption – fell to 8.79m barrels a day, the lowest level since late January. At the same time, crude imports averaged 9.8m barrels a day over the same period, up 10 per cent on the previous week.
MORE OPTIMISTIC
Crude for November delivery, the new front-month contract, last Wednesday fell 3.9 per cent, to $68.97 a barrel on the New York Mercantile Exchange, after falling as low as $68.57.
Also pushing prices lower is that global demand is still not matching the increased supply of oil, even though the International Energy Agency (IEA) is proving more optimistic about appetite for oil.
The international body has said that global demand for oil will not fall as far this year as previously forecast, thanks to stronger than anticipated demand in China and the US. But demand from OECD developed economies is still expected to fall by 4.7 per cent this year, and only grow by a margin of 0.1 per cent in 2010.
So, with high supply and continued weak global demand pushing prices down, spread betters should be looking for some tactical plays to make the most of the current range and also to position themselves best for any breakout.
Last week’s disappointing data sent crude oil prices plummeting, breaking below both the 55 and 100-day moving averages on the same day – the last time this occurred in a single day was as far back as summer 2007.
CMC Markets’ chief market strategist Ashraf Laidi says: “Aside from the double break of the moving averages, the breach below the neckline support of $69 suggests that this may emerge as the next obstacle for any rebound. A failure of this level risks calling up the next downside target of $62.80-90.”
Spread betters should therefore be looking at whether oil is able to successfully retest the $69 mark, which has become the new resistance level. Any move back up towards here in light of the weak data could see the price of crude oil bounce off the resistance level back down towards the low 60s.
Simon Denham, managing director at spread betting provider Capital Spreads, thinks we could see a move even lower, saying: “Bears of oil will probably be targeting the $62 mark and an even more aggressive move lower could see us test $58. Further evidence of inventory building will most likely keep a cap on oil prices and it shows that there is a huge amount of oil sloshing around above the ground.”
FLOATING STORAGE
The IEA noted that short-term crude floating storage levels declined to 50-55m barrels as of late August, down from around 65m barrels at the end of July. This should prevent oil prices from making a serious break northwards for some time to come.
However, anticipation of economic recovery should still keep oil prices supported so we are highly unlikely to see oil sink back towards its February lows. Spread betters should therefore look to buy on the dips back down below the $60 level.
Equally important for spread betters trading across the asset classes to note is the relationship between American equities and the price of crude oil, which have been trading very much in line over recent weeks.
Considering the strong positive correlation between crude oil and US stocks (+0.77) that has existed for the last three to four weeks, and the fact that the S&P500/oil ratio is currently standing at 16 – its highest level since April – analysts are expecting the S&P500 to follow oil prices lower, which could potentially bring the US index’s 980 support level into play.
Spread betters looking at crude oil may want to amplify their bearish position on the black gold by also taking out a short position on the S&P 500 in the anticipation that it will move lower.
Alternatively, given the strong correlation between the two, you may instead choose to hedge a short position in oil with a long on the US index.
It is not a perfect means of protecting your portfolio, but those looking to protect their capital may want to look at this as an option.
With the fundamentals pointing towards a short position, the bears could strike it just as lucky as the oil exploration companies.