Last week, the price of WTI crude oil dramatically bounced back and forth taking on steep gains, only to see them lost and regained yet again over several sessions.
The drivers for enhanced volatility continue to be the hard data around supply which is increasingly bearish, and the fundamental concerns about Iranian sanctions and Venezuelan supplies which is bullish.
Volatility is increasing in oil markets, which offer traders many potential trading opportunities.
Demand is no doubt slowing, and we see it slowing more, as global growth, a strong dollar, and startlingly weaker emerging market currencies, provide the mix to at the least take the edge off global oil demand, and at the worst cause it to move lower by a material mid-single digit percentage through the end of the year. In the near term, we are now entering seasonal maintenance seasons for refiners in the US, which should mean 5-6% less throughput to refineries which consequently means 5-6% more ending up in storage.
One of the more challenging conditions facing oil is the twin dynamics of slower economic growth globally, coupled with lower gasoline demand in the US year over year. And this is attributable to not only lower production, but also to less driving being done by cars and greater fuel efficiency.
Where Is The Price Of OIl Headed?
We do see signs the crude oil market is starting to shift in the direction of lower price. One of the best signals in oil markets is the term structure of the futures curve. The curve has been in a farily steep backwardation, which is normally bullish. A backwardation signals front month demand with a raised front month or spot price compared to out months. The opposite is contango, in which the spot and front month prics are lower due to over supply. In a contango scenario, the out months have a higher price which encourages producers to hedge into future months and store their oil. This creates a significant over supply and bearish environment for price.
Lately, the market has been shifting from a steeper to a shallower backwardation. As is often the case, it isnt so much the actual point value in time, as it is the shape, direction and velocity of the trend. In this case, the trend is shiting from more to less bullish or neutral. Last week’s curve was almost flat with only 44 cents seperating month 1 from month 4. Just 4 weeks ago, the spread was 2.5x that around $1.20.
There is a similarity when comparing to the term structure in October of 2014. Over 5 weeks through October, the spread between month 1 and month 4 went from 2.24 to 50 cents. Oil went on to lose 47% of its price from then through March 1st. Over the last 5 weeks, the month 4 to month 1 spread has moved from 1.19 to 44 cents.
Another potentially bearish factor is slowing global economic conditions which weigh on demand. World oil consumption is now flat to prior year. We see additional headwinds for China and India, primarily due to slowing economic growth and weaker currencies, which could shave off additional demand in Q4.
We see oil heading lower over the next 3-4 months. While there will be considerable volatility week to week, the structure should be bearish. The Iran situation could resolve many ways, including with India receiving a waiver to purchase more Iranian oil. With election season in the US upon us, a waiver to help keep prices low issued by the party in power would not be out of the question. In addition, there could be additional hurricanes, geo political issues, or other contributors to volatility. However, none of those change the basic dynamics; we have a lot of oil and a slowing growth environment globally. It is hard to see oil rise over the long term with that as a back drop.