Why Crude Is Likely To Drop Below $100 Again

As I'm sure you are aware, after skyrocketing to just above $130 on the prospect of no Russian oil on the world market following the Russian invasion of Ukraine, oil dropped just as quickly back to the mid-90s on news of peace talks, then retraced that move as far as the $100 level as the war dragged on, where it is hovering as I write. Obviously, that is some pretty spectacular volatility over a period of two weeks or so and it leaves two questions for traders. Is it going to continue? And, whether it does or not, where will the next move take us?

The answer to the first question is probably no, at least not to the same extent. Traders are like sports talk radio hosts; they are professional overreactors. Just as talking heads concerned with nothing but sports tend to see every trade and every scandal as the most important thing in the world on any given day because of their narrow focus, so a trader sitting at a desk monitoring news relevant to their market exaggerates the importance of every happening and utterance.

That mattered on the way up, where the possibility of the elimination of an oil source that supplies a small percentage of U.S. needs caused a nearly 50% spike in WTI. Yes, that problem hit an already tight market and yes, it came as demand was recovering from the latest hit from the omicron Covid variant, but even so…50%? The problem from a trading perspective is that even though you may know deep down that that makes no sense, you are almost forced to join in. I mean, who wants to get left out of a move like that? Even reluctant traders are dragged in, and once momentum takes a grip, it is hard to stop.

At some point, it was bound to turn, though, and once it did the same logic applied in reverse. All those who had been reluctantly drawn into the long oil party scrambled to get out, and the move down became as exaggerated as the move up. The problem is that too was based on an overreaction. Were there "peace talks" as state-controlled Russian media reported? Sure, but if you believe that Putin went into them with an open mind and in good faith and that they would therefore result in a "solution", I have a bridge in New York to sell you.

This has all the makings of a long, drawn-out conflict. On one side, you have an autocrat who has begun to believe his own propaganda and really believes that without the evil western influence, the Ukrainians would be welcoming him with open arms as he "rightfully" reclaimed Russian land. He may be delusional, but he isn't about to withdraw. On the other, you have a nation with a strong cultural identity and a history of suppression by Russia who have simply had enough. They have the sympathy of NATO countries but aren't a member, so the U.S. and others aren't obligated to fight on their behalf. History tells us that the most likely scenario, therefore, is NATO countries will give enough aid to Ukraine to prolong the struggle, but not enough to actually win. For the sake of humanity and the Ukrainian people, I hope I am wrong, but I fear I am right.

So, the sudden move up and the sudden move down were both overreactions, which probably means that after the 23% retracement of a collapse that took us back to the launch point of the initial move up, we are right around where we should be at this point. That should dampen volatility for a while. As to the direction of the next move, eventually an old oil market cliché will apply…The cure for high oil prices is high oil prices.

Crude above the psychologically important $100/barrel level has two impacts. First, it encourages marginal production. Even in an unfriendly regulatory environment and with an uncertain long-term future for oil, the potential short-term profits from $100 crude will be just too hard for many to resist. Simultaneously, though, $4+ gasoline in the U.S. and the equivalent elsewhere will discourage driving and reduce demand, or at least demand growth. It will also accelerate the move to EVs over the long-term.

That suggests that with the immediate panic over, crude will drop back below $100 and slip into a gradual decline for a while. That is what has always happened in the past after volatility such as we have seen recently, and it is probably what we will see this time too, but care is needed if trading that view. The war in Ukraine will continue. Wars create headlines, and headlines move markets, so risk mitigation by way of stop loss levels that you stick to will be essential. That said, though, a period of short bias in oil trading looks like a sensible strategy from here.