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Brian Noble

Brian Noble

Brian Noble is principal with Financial Communications in Toronto, Canada which specializes in communications initiatives for the Canadian and global financial services industry. Brian Noble MA,…

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Is A Big Move In Oil Prices Due?

Barrels

In options trading, a straddle is literally a sit-on-the-fence strategy. By purchasing a put and a call at the same strike (price of underlying commodity) for the same time period, an investor isn’t making a conventional directional bet; rather the investor is looking for a big move either up or down. The rub is that the big move must be greater than the sum of the two option premia or the bet goes south. But that is in the nature of the trade.

From a fundamental industry perspective (Conflicting News Keeps Oil Prices Down to a more specifically trading focus (Are Oil Markets Becoming Untradeable?) confusion has reigned supreme in the crude oil markets of late. WTI is down about 12 percent for the month of June and is set for its longest run of weekly declines since 2015. In addition, crude has been displaying considerable price volatility on a day-by-day basis, largely to the downside. So would anybody be putting on a straddle in the WTI market today? Let’s assess the situation.

Bullish considerations:

Hurricane season in the Gulf of Mexico is upon us early.

If rigs go offline because of a vigorous hurricane season, production will be shut-in and crude prices will rise. The first storm of the season has already made land-fall, and the usual season is August-November, so the storms are early this year.

How good a job can OPEC do in terms of maintaining production cuts, discipline and compliance within OPEC and non-OPEC?

If OPEC succeeds at making the cartel march to its tune, then all will be well. In addition, future even deeper cuts will help support the oil price. What realistically are the chances of that?

Can Saudi Arabia really influence the EIA inventory numbers?

The Saudis say that the current OPEC cuts need time to impact the market. But can they themselves surreptitiously impact the market? Analyst John Kilduff of Again Capital interviewed by CNBC has made the novel suggestion that it is in their hands by changing the flow of exports from the U.S. to other markets with the effect of decreasing inventories artificially. He also thinks that unless OPEC cuts much deeper, the current game of chicken is going to continue among market participants. Related: What’s Wrong With The U.S. Oil Export Boom

Is there a credit crunch looming in the patch?

At current lower crude prices, U.S. shale production could be negatively impacted over the next few months and some production could come off line as producer cash flow dries up and some of the hedges from last year begin to run off. Less drilling activity will put upward pressure on prices.

Where is the U.S. dollar really going?

If U.S. rates are going to the moon, then the U.S. dollar will rise and commodity prices fall. But what if the Fed is done with the current rate cycle? Recent strength in WTI this past week is probably a reflection of a weaker U.S. dollar—is this a sign of things to come?

Bearish considerations:

The fundamental macro-economic backdrop to WTI has been bearish.

The CITI U.S. Macro-Economic Index (or Surprise Index) recently plunged to a six year low, meaning that economic data have been exceptionally disappointing. Global economic growth has been anything but robust, including a weak U.S. GDP print of under 2 percent, while even in so-called faster growing Europe, macro-economic conditions are soft.

Despite OPEC’s best efforts, the supply/demand dynamic was not effectively addressed.

Increasing U.S. production and higher domestic rig counts have also undercut OPEC’s attempts to limit supply. At the same time, declining U.S. demand for gasoline has been mirrored by declines in Japan, China and the rest of Asia. All OPEC producers, including the Saudis, have actually increased production in the last two months.

Having said that, increases in U.S. shale production, growth in DUCs and global inventory levels matter.

Limits to Nigerian and Libyan production were simply disregarded by OPEC at its May meeting, while both countries have made a surprisingly robust recovery in terms of production. But the domestic U.S. industry has proved so resilient in terms of using cost-effective technology that inventory levels remain elevated. Related: Oil Markets Unmoved By Brewing Conflict In The Middle East

Who really believed the OPEC charm offensive?

The 25 May OPEC and non-OPEC member meeting in Vienna was bruited to be make or break. But even with the agreed production cuts and their 9-month extension, the cartel has been unable to keep its act together, as compliance issues are paramount and it is obvious that OPEC members are pursuing their own agendas (OPEC Members Pursue Own Agenda As Glut Persists)

The technical picture was deteriorating.

WTI was unable to break out of its $52-54 upside range. Instead, a pattern of lower highs and lower lows has been apparent since early May. Recently, WTI broke major support at $45, while Brent completed a death cross (Brent Stands at Death’s Door With Bearish Cross Formation: Chart) where the 50-day moving average falls below the 200-day, which last occurred in the latter part of 2014.

Straddle this market or not?

Violent price swings in tech stocks, gold, oil and other asset classes are a result of the preponderance of algorithmic trading plus high levels of leverage prevalent across all markets today. What used to be price discovery is now essentially noise.

Just to reiterate what I said on 6 May 2017 (How Much Further Could Oil Prices Fall?), my one dollar/one euro/one pound (name your currency) bet would still be that oil goes back to the high $20s-low $30s as it did in the winter of 2016 before it goes back above $60.

By Brian Noble for Oilprice.com

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  • John Scior on June 28 2017 said:
    One of the most excellent analytics I have read. A few comments. 3 factors to consider for the Bull side : 1. War in the persian gulf strictly limits OPEC supply not by "agreed upon voluntary restrictions" but by real actual physical barriers such as destruction of exporting and production capabilities . We currently are witnessing an arms buildup in the middle east. A tinderbox full of matches. 2. Collapse of the Venezuelan government and subsequent destruction of exporting capabilities constrains supply. 3. US-China relations regarding N. Korea and s. China sea could ultimately lead to War between the two nations. No one really wins in War ( especially if it escalates to the point of a nuclear bomb being lobbed one way or the other ) , however the resultant increase for demand for oil and fuel to feed the war machine has the potential to send prices skyrocketing.
    On the Bear side : my comment would be that the increase in interest rates by the fed or divestiture of assets obtained in Quantitative easing or any combination thereof would have the effect of constricting the money supply thus making dollar more valuable. If other nations do not follow suit , they risk capital flight where money leaves their country in search of greater returns. However this ultimately plays out, the higher value of currency due to said factors means the trade value of oil in exchange for currency points to downward price pressures. Also, worldwide demand would slow as economic contraction is the inevitable outcome. As demand falls so does the price.
    In regard to your proposed wager, would you accept this hypothetical proposal ( so as to not violate laws regarding internet gambling - I'd rather play chess ) but you pay 1 Bitcoin - if you lose and I pay 1 dollar if I win. For clarification of the nature of the win lose proposition- I win if the price ever reaches above $ 60.00 US dollars for lets say WTI ( currently at 44.88 ) before said WTI reaches a price in the ( US dollar $ 28.00 - $ 32.00 ) closing price end of day . You Win if the closing price ever falls below WTI 32.00 and the WTI closing price has not attained above US dollar $ 60.00 { i re-iterate this is merely a thought experiment , not an actual offer or proposal }
    P-K4
  • John Scior on October 30 2017 said:
    I would be wealthier by one hypothetical Bitcoin if I had just said Brent Instead of WTI by now.
    N-KB3

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