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Oil – news and data reports drive prices lower

  • Price volatility picks up as oil trades mid-channel
  • Demand and supply factors apply bearish pressure
  • Downward trend forming (weekly timeframe)
  • The extra volatility opens the door to trading oil-based equity pairs

The price of oil continues to fall as a combination of factors impact both supply and demand. For much of 2019, it has been trading in a channel between the $50 and $65 levels. The support at $50 appears pretty firm and price action over $60 never really looks like it has enough momentum to make a breakout to the upside. Currently trading mid-range, the oil price is picking up in terms of price volatility as bears and bulls both see an opportunity to make profits.

Oil CL1! – Year to date:

Source: TradingView

Since April’s highs, the price has been forming a downwards trend. As ever, there is a relatively high amount of price volatility in the commodity. Over the last month, the CL1! Future has posted a high of $59.93 on 16thJuly and a low of $50.50 on 7thAugust. On Wednesday and Thursday, the price fell away by more than 5% only to recover again on Friday, with WTI crude currently trading at $55.30 – an increase of 1.52% on the previous close.

Source: OilPrice.com

 

Demand

Demand, and more specifically projected demand for oil, has fallen away due to wider concerns regarding the global economy.

The US-China trade wars are currently escalating. President Trump’s decision to hold off on the introduction of some tariffs that are due to come into effect on 1st September reflects an unwillingness to damage his US voter base rather than an appetite for reconciliation. Korea and Japan, both big net oil importers, are engaged in their own spat, and the European Union and UK could be heading towards a no-deal Brexit.

Even without the trade war to consider, there are other reasons to suggest oil demand growth will be downbeat. Economic data reports out earlier in the week showed the German economy contracted in Q2 2019, meaning that for two of the last three quarters it has reported negative growth. Yield curves on the treasuries of several major governments have inverted, causing analysts to consider for what reason ‘this time it’s different’ and why the flip in yields might not be an indication of recession. An illustration of the extent to which investors are rotating away from risk was seen on Wednesday when the US Treasury bond yield curve inverted for the first time since 2007.

Smaller economies – ranging from India, Thailand and Indonesia – have all recently cut interest rates. Furthermore, the Reserve Bank of New Zealand last week seized the opportunity to cut rates by 50 basis points rather than 25 basis points in expectation of the situation getting worse before it gets better. Whilst this pack may be seen as followers rather than leaders, their pre-emptive actions demonstrate a belief that a multitude of central bankers are buckling up for a bumpy ride, and that demand for oil could be about to slide.

 

Supply

Projecting supply of oil is harder to do due to the political variables that are in play. An interesting report by CNBC outlines how Saudi Arabia is ‘dramatically changing its oil exports to China and the US’.

Natasha Turak has run the numbers and notes:

“Saudi Arabia’s crude shipments to China have doubled in the span of a year. During the same period, its oil exports to the US have dropped by nearly two-thirds.”

Source: CNBC

Source: CNBC

The shift is partly explained by US sanctions against Iran forcing major oil importers such as Japan to build up their relationship with the Saudis. The US is also increasingly self-sufficient due to shale gas operations coming on-line. There is however a cunning sub-plot, as outlined by Matt Smith, director of commodity research at commodities analytics firm ClipperData:

“Saudi Arabia learned from the last OPEC production cut in 2017 that they got the biggest bang for their buck by cutting flows to the largest, most transparent and most timely market — the US… Choking back on flows to the US was the best way to draw down inventories and turn around bearish sentiment, and they are employing the same tactic once again.”

 Source: CNBC

At best, Chinese economic reports are regarded by the general markets as ‘opaque’. The inventory data that the market follows is drawn from reports emanating from the more reliable and transparent US.

The Chinese plan might be a good long-term policy, but in the short term at least, it’s missing the target. The US Energy Information Administration reported that during the week ending 9thAugust, the Strategic Petroleum Reserve of commercial crude oil increased by 1.6 million barrels.

More ‘traditional’ issues regarding supply are also much in play at the moment. The release on Thursday of the oil Tanker Grace 1 by Gibraltar authorities opens the door to further conciliation and the possible release of the Iranian held Stena Impero. This also highlights the supply line is prone to disruption from what is effectively state sponsored piracy.

 

Oil equities

Short term price moves are very much part of oil’s DNA. The commodity itself and the equities operating in the oil production sector are popular among traders for the very reason that there are substantial price moves that can generate profits (but also losses). With the 2019 equity bull market showing signs of weakness, the general direction of the equity market is more in doubt than usual.

Some might be considering a ‘pairs’ trade, going long one equity and short another, and trading the relative strength of the two assets. By setting the trade up with equal weighting to the upside and downside, traders can mitigate market risk and look to trade the spread. The strategy is not designed to generate massive returns, more to squeeze profits out of the market when taking a naked position – this could be as risky as flipping a coin. The extra volatility in the underlying oil market can cause the spreads on the oil equities to move into profit fast enough to negate the financing costs involved. One perennial favourite pairs trade is the London listing of Shell Oil (Ticker: SHELB) and BP (Ticker: BP).

BP – Shell ‘B’ – share price – five year:

Source: TradingView

BP – Shell ‘B’ – share price – five day:

Source: TradingView

 

The oil shares have always been subject to geo-political events. At present, the list of factors to consider is getting longer rather than shorter. All positions incur some degree of risk, particularly when price volatility picks up.