A Risky Bet On Crude Oil

There are a lot of things about the coronavirus scare that are surprising. The abandonment of any hint of logic by both the public at large and financial markets would be one. Staying clear of Corona beer and boycotting Asian restaurants whose owners and staff have probably never even been to China spring to mind from the general public, while global stock markets are pricing in massive declines in GDP and corporate profits at this early stage would be the most obvious, possible overblown, market reaction.

For the oil market specifically, the fact that a major announcement from OPEC this week went almost unnoticed seemed the most surprising, until you read the proviso to the announced production cuts. They still had to be approved by Russia, and this morning there were reports that that wouldn’t happen. Subscribers to Oil Price Alerts won’t have been shocked by that, as I wrote in a subscriber e-mail written yesterday that it was a risk.

My point was that Vladimir Putin plays the long game, and if he perceives this market turmoil as doing more damage to European nations and the U.S. than it is doing to Russia, he will take the short-term pain for possible long-term gain. Right now, that looks to be the case.

Still, the reaction to that news, like just about everything else at the moment, looks like being overdone, or will be quite soon.

Even if Russia doesn’t join there may still be further cuts from other producers, as well as market-driven supply reductions in countries where economics, not government diktat, drive decisions. Those cuts will be to offset the potential impact of coronavirus, but the key word there is “potential”.

I don’t intend to belittle people’s fear. We are being bombarded with talk of coronavirus. Every sector of the news and entertainment industry is on the story, from business to entertainment news, to sports news and beyond. There is no escape, and when the coverage is ubiquitous, it gives the feeling that the disease is too. But it isn’t. It is spreading faster than most of these things have in the past but is still nowhere near as much of a problem as the flu is every year.

From a market perspective though, it is the uncertainty and the reaction, not the current impact that is the point. This could have a massive effect on global consumption, so it could be very impactful for oil. Then again, it might not. But the fact is that the worst-case scenario is being priced into all markets, and mitigating policies and actions are being ignored.

That intrigues the trader in me as it is an obvious case of a distorted risk/reward ratio. It smells of opportunity.

Now it could be that bears are right and that this is the plague to end all plagues and that the effects will be massive and long-lasting. The history of these things, however, suggests that before too long, the coverage, and thus the fear, will fade. That could be seasonal, or it could be the effects of quarantining, or it could be that a vaccine will be discovered. It could even be that people just get bored with it and decide to carry on with their normal lives.

Whatever the reason, though, there is at least as much chance that the effect is relatively limited as there is of economic Armageddon. Markets, including oil aren’t pricing it that way, however.

When OPEC announced that they had reached an agreement without Russia, the markets were rightly skeptical. With the risk of Russian non-participation now priced in to some extent and the worst-case scenario being assumed for coronavirus, WTI is close to a critical level.

$42 has been the bottom of two big moves down over the last three years. It is in the nature of chart points that they sometimes get overlooked at times of outright panic, but this is obvious and significant enough to probably draw some attention.

At the time of writing, the main WTI futures contract, CL, is trading at around 42.50, and a small position there with a stop just below 41.50 looks too tempting to resist.

This is not for the faint of heart as buying into a full-blown panic has a low success rate. It could even be that by the time this piece has been edited and sent and you get around to reading it, the massive volatility will have caused that position to already be stopped out. However, with appropriate risk management, the risk/reward ratio makes it worthwhile exploring opportunities for long positions down here, so if that is the case, I will have already taken a loss and will be looking for the next level to buy. Nothing ventured, nothing gained!