The trader’s guide to “Lower for Longer” oil

March 15, 2016 01:00 PM

No market has captivated traders more than crude oil since it began an historic downturn in the summer of 2014. The story of the move is a fundamental one in a market where many experts had stopped believing in fundamentals. We, along with a team of seasoned analysts, attack it from all angles. 

Donald Luskin explains why the onset of low-priced energy has harmed global economies instead of providing an engine of growth, and how and why that will change in “Crude cause and effect.” In “10 decisive oil forecasts for 2016” Sean Levine breaks down 10 likely energy scenarios for the rest of the year. Levine also explains why he feels the crude oil market has still not resolved its supply issue. 

While the revolution in shale oil production through fracking is the game changer that turned the industry on its head, Saudi Arabia is still the key player and may have some big news to report. Ellen R. Wald discusses the possibility of a Saudi Aramco IPO in the future and what it could mean to the industry in “Saudi Arabia Inc.?” In “Does OPEC spare capacity matter,” Hilary Till provides guidance and a fundamental fact traders should follow. Neil Azous breaks down how crude oil is correlating with other major sectors and our trend following story provides an outlook for what to expect this year. 

Just as high prices persisted longer than perhaps they should have, many folks foresee low prices persisting a bit longer. Once people start believing, that is probably when the market will turn.

The bear market in crude oil has persisted since the summer of 2014 and despite some serious and strong rebounds, does not appear to be over yet.

A maxim of economics is that high prices are the cure for high prices, and low prices are the cure for low prices. 

Another maxim of trading, and economics, is that markets can stay irrational longer than most traders can stay solvent. How does this relate to the current situation in energy markets in general, and crude oil in particular? It is that a bottom — just like a top — will happen and markets will reverse. But also, that long-term moves tend to overshoot the mark and what the fundamentals would require. So just as crude oil stayed at improbably high levels much longer than most people expected and much longer than the fundamentals justified, they can go lower and stay lower longer than many people expect. 

And while many experts expect a reversal, there is not even a consensus on what the fundamentals suggest. Many analysts believe that the large supply glut caused by increased production because of the fracking revolution and slowing demand growth has not been worked out and until it is, talk of a bottom is pointless. 

“Globally we have Iran that is going to be coming online soon with a lot more production. The Saudis are drilling aggressively, Russia is trying to increase production and Iraq is increasing production; so it is not just here, it is a lot of other important places that production is moving in the wrong direction,” says Sean Levine, director of research and product development at Energy Capital Research Group (see “10 decisive oil forecasts for 2016). “You can’t get to the bottom if nobody will ever reconcile the fundamentals. We don’t have a [target as] the pricing is completely detached from fundamentals because the market is not fulfilling its function of matching supply to demand appropriately. Until that happens, it can go as low as it needs to go until somebody blinks.” 

Founding Partner at Energy Management Institute Dominick Chirichella agrees. “There is a lot of oil around the world, and yes eventually the world will be rebalanced but I don’t believe the market has found a price yet where the surplus starts getting cleared at an accelerated rate,” Chirichella says. “We can stay low for an extended period. We can easily go to $20 per barrel; we can easily go to $15 per barrel. It is fascinating that places like Canada where oil is selling from $12 to $15, places like Venezuela where heavy oil is selling for $10 to $12 per barrels, [crude] is still being produced.”

And that includes the United States. “At the end of the day the growth of shale has come down but based on [the Jan. 27 numbers] current production levels are pretty much at the same level it was at one year ago for the same week (see “Frack on,” below). It is still coming,” he says. 

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About the Author

Editor-in-Chief of Modern Trader, Daniel Collins is a 25-year veteran of the futures industry having worked on the trading floors of both the Chicago Board of Trade and Chicago Mercantile Exchange.