3 Reasons To Be Bearish On Oil

When WTI futures turned negative in April, it was something never seen before, and hopefully, something that will never be seen again. As unusual as it was, though, it was understandable. Economies around the world had been completely shut down almost overnight. Driving and flying, and therefore oil consumption, had dropped to just about zero, and all that happened too quickly for production to adjust. There was still oil coming out of the ground, but nobody was using it and there was nowhere to put it. Prices had to collapse. It was a simple, if exaggerated, supply, and demand issue.

The recovery from that has been quite remarkable, given the circumstances. Driving and flying aren't yet back to previous levels, but crude futures (CL) have been trading in a fairly respectable $35-$45 range for three months or so. That is way off the highs in the $60s at the beginning of the year, but manageable for most producers.

There are, however, three reasons to think that we may be soon breaking out the bottom of that range.

1: It's the Economy, Stupid!

Let's face it, even though the White House is working overtime to have you believe otherwise and the stock market has, until quite recently been booming, the U.S. economy is a bit of a mess. People are going back to work and growth has returned, but at nowhere near the pace anticipated by the bulls a few months ago, and we are still way off the strength we had gotten used to.

An unemployment rate of 8.4% is better than double digits I guess, but it is still objectively bad. Similarly, however you look at it, there have been two consecutive negative prints of GDP growth, with the second being the largest one-quarter decline in history. We may bounce back from all that, but with coronavirus resurgent wherever things were opened too fast, a lot of employers suggesting that job cuts will be permanent, and most schools still part-time at best, that isn't happening quickly.

As if that weren't bad enough, this isn't just an American problem. The situation in places like the U.K., Spain, and France is also worrying, with a renewed surge in cases prompting calls for another complete shutdown.

2: Politics:

Lest it has escaped your attention, the U.S. is just over a month away from an election.

That often causes some market weakness, especially when the leader in the polls is a Democrat. Yes, I know that there are data that show that U.S. markets do better with Democrats in the White House, but that isn't the point. The prospect or reality of a Democratic President always causes selloffs. You may think that is perfectly logical, or you may think it is completely unfair, but, as my old boss used to say, the market doesn't give a $@%! what you think. A Democrat leading in the polls will usually produce a risk-off environment, whatever your opinion of that fact and Biden's pro-renewable energy policies will worry oil traders.

That tendency to drop on an expected Democrat win is even more exaggerated this year than usual. Biden's poll lead is substantial, prompting Trump to attempt to make excuses for a big defeat in advance. Most notably, he has said that any loss will be because of cheating, and he won't commit to a peaceful transition if that were the case. If Biden does manage to pull a Hillary and snatch defeat from the jaws of victory on the other hand, Democrats will point to the poll numbers and say that the election was obviously stolen from them by Russia, Trump, or the GOP in general.

Either way, and with coronavirus fears resulting in massive numbers of absentee ballots, it is very unlikely that America will wake up on November 4^th with an undisputed newly elected President. Extended court cases at best and a full-blown constitutional crisis at worst look sure to follow the vote, and the anticipation of that kind of chaos will weigh on oil as well as stocks.

3: Supply

Most of the oil market's focus over the last few months has, understandably, been on demand. The decimation of demand for oil was devastating, and the rate of recovery from that is obviously the most important factor in price.

However, supply matters too.

Not that long ago, it wouldn't be the potential problem it is today. When OPEC controlled a massive percentage of the world's production, they simply had to say the word and the oil would cease to flow. Now, however, with the U.S. being the world's largest producer and OPEC responsible for only around 40% of the world's crude supply, output can't be controlled by diktat alone.

Market forces will be in charge, and the impact there is not as predictable as you might think. In theory, that massive drop in demand should have resulted in an equivalent drop in supply, but that wasn't the case in North America. As I said, demand fell almost to zero, whereas supply fell by around 20%, according to EIA data.

Obviously, demand is no longer at zero, but without a commensurate long-term supply adjustment, any slowing of that return such as detailed above is likely to cause an exaggerated response in price.

As you can see, there are three very good reasons that oil should go lower. As any trader knows all too well, though, should and will are not always the same thing. Most of these things have been true or known for a while, but CL has remained quite steady for months. However, the longer all three remain as they are, the more downward pressure on crude there will be so favoring short crude positions for a while is the logical thing to do.