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Boone Pickens, on CNBC, recently said oil was over supplied currently. This world renowned expert expects a downward movement in oil prices in the near to medium term. The Libyan oil is coming back online more quickly than early estimates indicated. In Nov. Libya was already providing 600,000 bopd to world markets. Libya’s National Oil Corporation said it expects to provide 800,000 bopd of light sweet crude to world markets by year end. OPEC officials estimate that Libyan output will return to pre-conflict levels by mid-2012. The 300,000 bopd that will be available at the world level once the 150,000 bopd Seaway pipeline (to Cushing, Okla. from the Texas coast) is reversed in the spring of 2012 should act to lower overall oil prices too. The extra oil that the Saudi’s have provided to replace the Libyan oil may not disappear.

With the extra continuing expenses the Saudi government recently incurred in compromising with the Saudi rioters, the Saudi government will be loathe to curb their production. They are using the extra income to pay for the increased benefits they acceded to. Other OPEC economies that are hurting will likely over produce too. Admittedly there is talk of an EU ban on Iranian oil for political reasons. To me this seems unlikely as the EU is moving steadily into recession. Higher oil prices due to a self imposed ban on Iran exports would only exacerbate the recession(s). All this means that the price of oil is likely to go down in the near term.

The secular growth in energy demand due to emerging markets growing energy demands is still in place longer term; but shorter to medium term we may see a move downward, especially if the EU Summit disappoints investors. Such a disappointment would presage a deeper EU recession(s). I’m sure most people can remember the commodities crash as the recent US recession took hold. The EU mediated commodities crash should be smaller. Futures trading rule changes have prevented many futures from becoming as over bought as they were before the US recession. Plus the EU is not quite as much of an oil glutton as the US, so the decrease in EU demand for oil will be smaller than that seen in the US. Still an EU decrease in demand is coming.

In the shorter term, the EU credit crisis events may provide more dramatic moves either way. However, medium term the EU recession should move commodities prices downward. It is less clear whether this down move will include gold, but just about everything else should come under significant pressure. Even EU food consumption may lessen. The EU recession(s) will also have trickle down effects on its major suppliers such as the US, China, and Japan (and on its minor suppliers too).

There are many ETFs one can use to trade this likely downturn. A few of these are: The United States Oil Fund (NYSEARCA:USO), the iPath S&P GSCI Crude Oil TR index ETN (NYSEARCA:OIL), the PowerShares DB Oil Fund (NYSEARCA:DBO), the Direxion Daily Energy Bear 3X Shares (NYSEARCA:ERY), and the ProShares UltraShort DJ-UBS Crude Oil fund (NYSEARCA:SCO). A short description of each is below.

The United States Oil Fund (USO) seeks to reflect the performance, less expenses, of the spot price of West Texas Intermediate (WTI) light, sweet crude oil, other types of crude oil, heating oil, gasoline, natural gas, and other petroleum based fuels that are traded on exchanges. It may also invests in other oil interests such as cash settled options on oil futures contracts, forward contracts for oil, and OTC transactions that are based on the price of oil (Yahoo Finance). Daily Volume is 12M+.

You can short this fund or you can buy put options on the USO. Since the VIX is near 30, straight options are overly expensive due to volatility. This means that you are more likely to make money by buying put spreads on the USO. I note you do not face double the volatility premium in this case because the fund manager(s) is trying to reflect an upward bias. This is how futures contracts work. This means the decay in volatility and time premium in the fund investments will work in your favor if you bet the ETF down with put options. This is more true if you use a put spread strategy.

You can make virtually the same investments with the iPath S&P GSCI Crude Oil TR index ETN (OIL) as I described above for USO. OIL is linked to the performance of the Goldman Sachs Crude Oil Return Index and reflects the returns that are potentially available through an unrevealed investment in the futures contracts comprising the index plus the Treasury bill rate of interest that could be earned on funds committed to the trading of the underlying contracts. The index is derived from the West Texas intermediate (WTI) crude oil futures contract traded on the New York Mercantile Exchange. The average daily volume is about 600K (Yahoo Finance). This fund is more specifically oil than USO, but it is far less liquid.

You can make virtually the same investments with the PowerShares DB Oil Fund (DBO) as I described for USO above. DBO seeks to track the price and yield performance, before fees and expenses, of the Deutsche Bank Liquid Commodity Index -- Optimum Yield Oil Excess Return. The index is a rules based index composed of futures contracts on Light Sweet crude Oil (WTI) and is intended to reflect the performance of crude oil. The average daily volume is about 400K (Yahoo Finance). Again this is more specifically oil than USO, but it is much less liquid.

The Direxion Daily Energy Bear 3X Shares (ERY) seeks daily investment results, before fees and expenses, of 300% of the inverse of the performance of the Russell 1000 Energy Index. The fund, under normal circumstances, creates short positions by investing at least 80% of its net assets in: futures contracts; options on securities, indices and futures contracts; equity caps, collars and floor swap agreements; forward contracts; short positions; reverse purchase agreements; ETFs; and other financial instruments that, in combination, provide leveraged and unrevealed exposure to the index.

It is non-diversified. Its daily trading volume is 5.3M (Yahoo Finance). Since this fund is already levered (3X), it is wise to just buy this ETF directly as it is already shorting oil. If you buy put options on it, you will be paying twice for volatility and time premium. This will make it much more likely you will lose money.

The ProShares UltraShort DJ-UBS Crude Oil fund (SCO) seeks to provide daily investment results (before fees and expenses) that correspond to twice (200%) the inverse of the daily performance of the Dow Jones UBS Crude Oil Sub-IndexSM. The fund invests in any one of or combinations of the financial instruments (swap agreement, futures contracts, forward contracts, option contracts) with respect to the applicable fund’s benchmark to the extent determined appropriate by the sponsor.

It invests in other assets in cash or in cash equivalents and/or US Treasury securities or other high credit quality short term fixed income or similar securities that serve as collateral for the financial instruments. The average daily volume is 1.39M (Yahoo Finance). Since this fund is already levered, it is wise to just buy this ETF directly as it is already shorting oil. If you buy put options on it, you will be paying twice for volatility and time premium. This will make it much more likely you will lose money.

These are some good ideas for shorting oil in the coming commodities sell off due to the EU recession. The likely ECB cut in interest rates on Thursday Dec. 8, 2011 may actually help oil rise. A good result from the EU Summit on Friday Dec. 9, 2011 would likely have the same effect. Unfortunately such a result is not likely to occur. Still it is safer to wait until you see the actual result Friday. For those with more risk tolerance a put option spread on USO can be bought fairly cheaply late on Thursday.

A quick look at the two year chart of the USO should provide some technical direction for the trade (see below).

click to enlarge

USO is near over bought levels in the slow stochastic sub chart. This is a good thing if you are thinking of shorting it. It is also important to be aware of the roll dates for USO. Each month the futures contracts need to be rolled forward. Some have estimated that this process costs approximately 3%. This too is a good thing if you are thinking of shorting the fund (or buying a put spread on it). The relevant near term roll dates are Dec. 6-9, 2011, Jan. 6-11, 2012, Feb. 7-10, 2012, and March 6-9, 2012.

If you want more dates, you can follow this link. USO is at a level of strong overhead resistance. If the EU Summit encourages the market to continue upward, it seems likely that USO will go through this resistance. However, the more likely scenario is that it will head downward in the near term. The more likely scenario is that the EU Summit will not satisfy the market. Again the safest course is to wait for the result of the EU Summit. Risk takers might take a bigger risk by buying a put spread on the USO.

In sum, taking Boone Pickens' advice about the short to medium term price of oil is probably a winning strategy.

Good Luck Trading.

Source: Boone Pickens Says Oil Is Over Supplied Near Term - Trade Accordingly