Looking For A Pattern In Choppy Oil Markets

We, as human beings, love to look for order. We have a problem accepting that not everything falls into neat patterns, so we go back, look at what happened in the past, and retroactively apply patterns to it. An awareness of that tendency is why I am naturally skeptical of much of the overcomplicated technical analysis that is popular amongst retail traders. Put simply, just because A led to B and C in the past doesn't, in any logical way, mean it will in the future.

That said, though, at times patterns can be observed that seem to happen for a perfectly logical reason and, at least until everybody is aware of them, they can provide a trading opportunity. Such a pattern has emerged in the recent chaos of the oil futures market, and looks like providing an opportunity for the next couple of weeks at least.

The pattern has come as a result of the fact that there are two inventory numbers released for U.S. crude each week; on Tuesdays at 4:30 pm the private American Petroleum Institute (API) releases their estimate of stockpiles, and the following day at 10:30 AM the official government numbers are released by the Energy Information Agency (EIA) which is marked by the red vertical lines on the chart below. The discrepancy between these numbers has created a pattern that is worth trading.

(Click to enlarge)

What has happened in each of the last four weeks is that the API has released a terrible number, suggesting massive stockpiles of crude in the U.S. that easily outstrip published expectations. That has (absent any other news) produced a slight move down, but what it has really done is set things up for the next day. Traders don't pay as much attention to the API number as the EIA one, except as a guide as to where the EIA inventory numbers may come in. This run of much worse than expected API reports has therefore resulted in some seemingly illogical moves up on Wednesday mornings. Whatever the actual number, after the pessimism engendered by the API estimate, futures have gained significantly.

On February 3rd, for example, despite a build in inventories of 7.79 million barrels against published expectations of a 4.76 million barrel build, oil rose around a dollar in trading following the release. That makes no more sense than this week, when once again a build that was higher than originally forecast, but not as bad as it could have been given Tuesday's API numbers, caused a spike in oil. The two weeks in between saw actual beats of expectations, so the jumps following those numbers at least made sense.

From a long term perspective, of course, the fact that inventories are building at a slightly slower rate than expected means little and is really a negative. From a global perspective there is still over supply, and demand, while increasing slowly, has some serious catching up to do just to make a dent in existing stockpiles. The same applies in the U.S., so while "not as bad as it could be" will produce short term rallies there needs to be more fundamental change for those rallies to mark the beginning of a real recovery in the price of oil.

Until that comes, though, we are likely to be stuck trading a range that looks roughly banded by $28-$35. Any opportunity to trade within that range is welcome, and the disparity between the API and EIA inventory reports has resulted in a situation where oil futures jump immediately following the EIA numbers each week, regardless of the actual number. At some point that pattern will break but until then I will keep trading it, thankful for at least some order in the chaos.