Tuesday, October 13, 2015

The Emotionally Charged Crude Oil Market

The bulls and the bears both had their go around today's trading session as a parabolic session leaves shares slightly lower than yesterday's close. After a light holiday session on Monday, investors sidestepped their way into the middle of the week with intentions to trade cautiously. Upon open (and after a slight loss from Dow and S&P futures), traders appeared to have been realizing short-term long positions which were established about a week ago. The Dow Jones low today, near 17,030, experienced a rebound to the green until selling pressure pushed it to a -0.12% loss late in the trading session. The Dow's returns are still positive for the trading week and remain bullishly above the 50-day moving average with the spread between the 200-day average inching smaller. Volatility gained for the first time in as VIX grew about 7.15% today. The NASDAQ and the S&P 500 showed patterns similar to the Dow's whipsaw movement but sustained losses around -0.35%. Investors continue to be wary of uncertainty surrounding an overall market move that neither their peers nor the Fed have sought to clarify. Globally, stocks performed marginally poorly as the Global Dow dropped by almost a full 1% on a volatile economic environment. The Dow Jones Transport fell -1.73% hinting at broad-based weakness that could develop into more downside risks for an economy looking to bounce. As the earning's season of fundamental adjustments presses on, price movement is most likely to be muted by an absence of macroeconomic direction. The Fed's hands remained tied until their next FOMC meeting as any emergency rate change would signal an urgency unhealthy to the financial system. Economic data has had nothing but a tepid effect on the psychology of investors who remain stoic in the face of resilient manufacturing data, stalled job growth, and a decrease in imports. Inflation, for the most part, remains relatively undisturbed despite easy monetary policy, and the money supply continues its shuffle between bonds and equity investments. Perhaps we could be observing a waiting move as crude oil prices look to make a major move after a small bullish surge. WTI and Brent benchmarks ended with losses even though they showed almost 2% gains midway through Tuesday. Instead, down about 1% each, Brent crude oil drops below the $50 level once more. The International Energy Agency produced a report today highlighting concerns of a supply glut continuing into 2016. Investors were glad to listen as the energy sector dropped -1.32% with large cap stocks losing as much as -1.95% and -1.71% (Marathon and Shell). As depressed prices continue, firms are gradually pushed to tighten spending with operation cost reductions or job cuts. Some companies caught in this position of decreasing wages as opposed to firing workers which create skilled shortages and share price attacks. Small, marginal decreases may signal investors that the oil and gas industry see a recovery in the near future as long-term solutions are not being used.

An issue that is typically discussed during a glut, but not always addressed with the proper perspective, is the notion of accurate fundamental pricing. Given the efficient market hypothesis, the commodity market should measure futures contracts at a value that takes into account all available information. Many investors feel that profits can be made because the market valuation is not this way. Similar to any supply and demand model, systematic movement in the equilibrium should create proportionate movement in prices. With a dash of emotional investing (illegitimate claims of a bullish or bearish outlook), profit taking might be possible.

Oil Price Compared To Production Statistics

Using a comparison of the U.S. and international benchmark spot prices and domestic supply statistics, an observation can be made about the amount of losses that were associated with supply increases. From the highest point in 2014 (the week of 6/13) to the latest supply report (10/2), WTI losses amounted to -56.31% and Brent losses to -56.19%. These losses began after fracking projects started increasing U.S. production and forced OPEC to compete for market share. Investors started shorting and selling with long positions being established periodically. After those positions were sold, the process repeated until traders had sunk its girth by more than half. Meanwhile, supply increases began midway through 2014 until its peak around the end of 2015's third quarter. Now, an 8.2% increase has been established with more decreases in the near future. Below the charts, I've calculated the rate of WTI/Brent losses per 1% increase in supply. The results were quite dramatic. Over the past year, prices have dropped almost 7% with one percentage supply gains. On average, an increase of 88,245 barrels a day of U.S. production would cause a -6.87% move from the WTI benchmark. After it's put into perspective, it appears there might be at least some emotional trading behind selling. While this doesn't discredit major bears, it still sheds a light on how drastic they have been reacting. Some may argue that the international situation is very different with OPEC increasing production by about 1.3 million barrels. I might argue on the contrary. OPEC themselves have forecasted almost 1.6 million barrels a day more consumption with lower oil prices. Yes, Iraqi oil is scheduled to slowly come back onto the market, but global investments in oil are also scheduled to drop by $500 billion by 2016. Could it be true that the fundamental situation has been overcome by the bears? Volume data behind price decreases have been thinning out with bullish surges matching and sometimes exceeding the crowd being the sell-offs. Prices are still more than half their high, but the supply and demand situation is improving. That is why I continue to be bullish on oil. Not eccentrically bullish, but enough to see prices back around the $60 at the New Year. The efficient market hypothesis is a very valid thought process, but in the fundamental case of the fossil fuel glut here, it may have to be dismissed as free markets finally take over the pricing of petroleum. OPEC's power has shifted away from them, but that doesn't mean illogical sentiment should overwhelm the pricing mechanism that is the free market.

1 comment:

  1. Agreed - a healthy market is one that inhibits excessive marginal production but ensures demand is slightly exceeded on average. We are below that balance in the market and the longer we stay below it, the higher and faster the rebound (past) that point will be. Gl in the markets.