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Alex Kimani

Alex Kimani

Alex Kimani is a veteran finance writer, investor, engineer and researcher for Safehaven.com. 

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The Case For $50 Oil

Oil trader

The oil markets appear to have successfully scaled a major wall of worry, with oil prices rebounding to multi-year highs. Brent crude settled near a three-year high at $77.25/bbl, its best level since October 2018, while WTI closed Thursday trading at $73.30/bbl, scoring the highest settlement since July. Behind the bullishness is growing optimism that looming debt trouble at China Evergrande Group (OTCPK:EGRNF) (OTCPK:EGRNY) can be contained, coupled with a lack of any hawkish surprises by the Federal Reserve. The Fed recently announced its tapering intention, thereby confirming its economic optimism. Oil demand is seen growing steadily amid an ongoing economic recovery while the supply outlook remains stable thanks to production discipline by OPEC+.

Meanwhile, adding to the bullishness is the latest EIA report that shows that U.S. crude stockpiles declined for a seventh consecutive week. According to the U.S. Energy Information Administration, U.S. crude inventories last week fell by 3.5M barrels to 414M barrels, the lowest level since October 2018. The EIA report was bullish overall, saying supplies will only get worse in the coming weeks due to stretched inventories and the fact that refiners are coming on back faster than the supply of crude oil is growing.

But another Wall Street bear is warning the oil bulls not to do a victory lap just yet.

In a recent tweet, Bloomberg Intelligence senior commodity strategist Mike McGlone says several commodities, including crude oil, may have peaked and could be poised for a "reversion to the mean," i.e., a major pullback.

"Iterations for an enduring commodity peak are growing, and the stock market may be the final support pillar. U.S. Treasury bond yields topped out in March. Copper, corn, and lumber peaked in May. The dollar has recovered since June and crude oil may have reached its apex in July, when China cut its required reserve ratio."

Reversion to the mean

McGlone notes that commodities have become highly dependent on rising equities, and says a stock-market stress test is necessary to determine which commodities are the most likely to sustain higher prices and which are due for a pullback.

Unfortunately, he says oil, copper, corn, and lumber belong to the latter category.

McGlone notes that the last two major declines in crude (2018 and 2020) were almost tick-for-tick with the S&P 500. The 20-quarter correlation between the Bloomberg Commodity Spot Index and the S&P 500 currently sits at 0.90, the highest reading since 1960. The BI analyst says the last time the correlation peaked was back in 2013, which was followed by the spectacular oil price crash of 2014, which then spread to the rest of the commodities complex.

"Now, there is a risk of WTI reverting back to its mean since 2014, which would mean a drop to around $50 a barrel," McGlone reckons.

McGlone says there's another bearish catalyst working against oil prices: Supply elasticity due to technological advancement.

"Five years ago, it cost about $50 to extract a barrel of shale crude, now it's closer to $30. Businesses have adjusted to Covid-19, as evidenced in our chart showing S&P 500 Ebit at a record high. If equity prices fall or earnings stall, the highly correlated commodity market risks a drop with greater velocity," McGlone wrote.

Skimming stones

Bloomberg Intelligence is not the only technical analyst who is bearish about the oil price outlook.

Last month, Standard Chartered Global Research described the current oil price cycle as a 'skimming stones' period of trading. 

The research outfit noted that the broad pattern over the past three months has been one of sub-cycles of rallies from starting points below USD 68/bbl for Brent, followed by reversals. Unfortunately for the bulls, the cycles have been getting flatter and faster, with Stanchart saying the next move is likely to be to the downside.

Related: Oil Trading Giant Trafigura Sees $100 Oil In Late 2022

According to Stanchart, the first skimming stones sub-cycle started in late-May, culminating in a Brent high of $77.84/bbl six weeks later. The next sub-cycle started below $68/bbl on 20 July with a high of $76.38/bbl two weeks later. 

On the charts, this pattern looks like skimming stones with each bounce less high than the previous one and the length between bounces gradually diminishing.

Stanchart has predicted that the end of the skimming stones phase will involve a period of consolidation followed by a breakout move towards the downside.


Stanchart says that whereas the possibility of the oil markets returning to range-bound conditions remains, the current momentum in fundamentals, particularly the surge on the spread of the delta variant, makes an eventual downside breakout more likely. 

Stanchart researchers have strongly refuted Wall Street's bullish positions saying that WTI price of $65/bbl or lower is more likely than $75/bbl or higher. Stanchart says its bearish view is informed by the fact that "...a significant amount of money has already entered the market in the Wall Street-generated belief (mistaken according to our analysis) that the balances are much tighter and justify USD 80-100/bbl."

Well, at this juncture, we are more concerned about Fed policy.

With the Fed set to start paring bond purchases as soon as November and hike interest rates in response to rising inflation, the dollar appears poised for an upward trajectory, which could be bad news for oil prices and other commodities.

By Alex Kimani for Oilprice.com

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Leave a comment
  • George Doolittle on September 26 2021 said:
    "the stock market is not the economy but commodities absolutely are" is absolutely true.

    The 1929 stock market crash did not in fact harm the US economy all that much save for in a spectacularly bad way in Oklahoma and "The Dust Bowl."

    Simply put the US economy was not nearly so leveraged back then or "financialized" as it is know of as today. So I would agree from the standpoint that any major correction in the US equity market (or even minor correction) could have a truly dramatic and outsized impact upon the US economy because it would cause a *CREDIT* contraction as was quite common in the USA in the 1800s(deflations, depressions, financial failures, personal fortunes ruined, etc.)

    Long US Treasuries
    Strong buy
  • Mamdouh Salameh on September 27 2021 said:
    There is no case whatsoever for $50 oil. This is so first because OPEC+, the most influential player in the global oil market won’t allow it and second because the fundamentals of the global oil market are the most robust since 2014.

    Never in the last ten year have we seen the global economy grow at 6.3% or more than double its growth rate in 2019 before the pandemic or the Chinese economy grow at 8.44%.These two important developments are coinciding with a steep decline in global oil inventories.

    Oil is here to say well into the future. Furthermore, Europe’s crisis has demonstrated irrevocably that ditching fossil fuels to achieve a rapid energy transition and net-zero emissions by 2050 is a fantasy.

    So there is a real and viable case for Brent crude to exceed $80 a barrel shortly and even touch $90 in 2022.

    I have always argued that a fair price for Brent crude is $100-$110 a barrel. Such a price is good for the global economy since it stimulates the three biggest chunks that make the global economy, namely, global investments, the global oil industry and the economies of the oil-producing countries.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London
  • Gregory Grider on September 29 2021 said:
    Only people Too Rich to Have to Care about the price of Gasoline want Oil Prices to go UP!
    What about the REST of us? Or, doesn't that matter?

Leave a comment

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