Crude Oil - Coming Sanctions Create Uncertainty

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About: The United States Brent Oil ETF, LP (BNO), Includes: DBO, DTO, DWT, OIL, OILD, OILK, OILU, OILX, OLEM, OLO, SCO, SZO, UCO, USAI, USL, USO, USOD, USOI, USOU, UWT, WTID, WTIU
by: Andrew Hecht
Summary

A new round of sanctions on Iran could be coming.

Crude oil is sitting at just under its 50% retracement level.

Brent is strong because of OPEC output cuts.

The U.S. president continues to press the cartel to produce.

BNO could be the best bet in the oil patch for the coming months.

In the leadup to the November 2018 sanctions on the theocracy in Teheran, the US administration led by President Trump went on a campaign to convince allies within the international oil cartel to increase their output of crude oil. In early October last year, the price of nearby WTI NYMEX futures rose to a high at $76.90 per barrel. After the Saudis capitulated in the wake of the Royal Family's alleged participation in the murder of Washington Post journalist and Saudi national Jamal Khashoggi in Turkey, the price of the energy commodity tanked moving to a low at $42.36 per barrel in late December. To keep the pressure on oil in October and November, the US granted exemptions to eight countries that purchase Iranian crude oil.

The price of the energy commodity recovered to just over $58 per barrel since the late December bottom. OPEC trimmed output by 1.2 million barrels per day at their late 2018 biannual meeting, and even though US output is up to a record 12.1 million barrels per day, the path of least resistance for crude oil has been higher in 2019.

The US is now preparing to tighten the screws further on Tehran, and that could mean we are in for more messages from the Oval Office to OPEC and a rise in speculative buying in the crude oil market. With exemptions to purchasers of Iranian crude in question and the potential for retaliation in the Middle East, we could be in for a return of price turbulence in the oil market.

The benchmark pricing mechanism for most production from the Middle East is the Brent price. Over two-thirds of the world's oil producers and consumers use the Brent benchmark for pricing. The United States Brent Oil ETF product does an excellent job when it comes to replicating short-term price moves in the price of nearby Brent crude oil futures.

A new round of sanctions on Iran could be coming

When sanctions on Iran took effect in November after the Trump administration walked away from the Iran nuclear nonproliferation agreement last year, the US issued exemptions to weight countries that depend on Iranian crude oil. However, the move surprised the crude oil market and was a factor that contributed to the decline from $76.90 in early October to a low at $42.36 in late December. At the same time, Brent crude oil futures fell from $86.72 to a low at $49.96 per barrel.

The waivers on Iranian crude purchases will come up for renewal in May, and President Trump could choose to remove even more of Iran's exports from the market at that time.

India purchases around 300,000 barrels of Iranian crude oil each day and it is seeking to extend its waiver, but it is possible that the US could deny the request to put additional pressure on the theocracy in Tehran.

Crude oil is sitting at just under its 50% retracement level

Since the December low, the price of crude oil recovered.

Source: CQG

NYMEX WTI futures have rallied to a high at $58.08 per barrel on March 13. The 50% retracement level of the move from the October high to the December low stands at $59.63 per barrel, just slightly above the current level.

Source: Barchart

The Brent futures, which are the benchmark for Iranian crude, were trading at $67.30 per barrel on March 13, with the 50% retracement level at $68.34. Both WTI and Brent are sitting at just below the technical levels on the upside as the decision on exemptions approaches. Brent traded to a high at $67.73 last week, only 61 cents below the midpoint from the high to the low.

Brent is strong because of OPEC output cuts

Brent has been stronger than WTI and is a bit closer to its 50% retracement level because of record US production at 12.1 million barrels per day according to the EIA, and output cuts by OPEC of 1.2 million barrels per day at their most recent biannual meeting. The impact of rising US production versus a decline in output by the cartel which counts Iran as a member has caused strength in the Brent premium over WTI.

Source: CQG

As the chart of May NYMEX WTI futures minus May ICE Brent futures illustrates, the premium for Brent has increased from $6.49 per barrel at the end of January to $9.07 per barrel on March 13. The high in the May premium for Brent came in November at $10.26, and the current level is a lot closer to the high than the end of January low. Brent is strong for two reasons, the first being the output decline by the cartel. The second is that the spread between the two benchmarks often serves as a barometer for political risk as two-thirds of the world's crude oil reserves sit in the Middle East. The potential for increasing tension in the region is likely contributing to the increase in Brent compared to the price of WTI over the past weeks. At the same time, there is a high correlation between the width of the spread and the price of both crude oil benchmarks. When Brent's premium rises, the price of the energy commodity tends to move to the upside.

The U.S. president continues to press the cartel to produce

US President Trump has not been shy in his desire for OPEC members that are US allies to pump up their volumes. Before the price of oil suffered its most significant correction starting in October, President Trump sent more than a few tweets to the Saudis and other producers in the region reminding them that he wanted the price of oil lower with Iranian sanctions on the horizon.

Most recently, as the price of oil rose above the $55 level again on WTI futures, President Trump sent another tweet that the price of the energy commodity is elevated, and production should increase. In October, the messages on social media and exemptions for Iranian crude caused the price of oil to tank. However, the tweets could be a smoke screen as the US policy towards Iran, and now Venezuela stands to take two significant producers of the energy commodity out of the market. It is possible that tensions will rise as the deadline for a renewal of exemptions in May approaches which could provide support for the price of the energy commodity. It is likely that the most significant impact will be in the Brent futures.

BNO could be the best bet in the oil patch for the coming months

The fund summary for United States Brent Oil ETF (BNO) states:

The investment seeks the daily changes in percentage terms of its shares' per share net asset value (NAV) to reflect the daily changes in percentage terms of the spot price of Brent crude oil. The Benchmark Futures Contract is the futures contract on Brent crude oil as traded on the Ice Futures Europe Exchange that is the near month contract to expire, except when the near month contract is within two weeks of expiration, in which case it will be measured by the futures contract that is the next month contract to expire.

The most recent holding of BNO include:

Source: Yahoo Finance

BNO holds a long position in the May Brent futures contract.

We are entering into a period where uncertainty will once again grip the crude oil market over the coming weeks. If President Trump decides to extend waivers on Iranian crude, we could see the price move lower. However, more pressure on the leadership in Tehran would come from additional barriers that curtail sales of their oil which raises revenue during a time when the sanctions already have a chokehold on their economy. I expect volatility in the crude oil market to increase over the coming weeks, and the number of oil-related tweets from the Oval Office to rise. The most volatility will likely come in the Brent futures, so BNO could be an excellent trading tool when it comes to approaching the crude oil market for those market participants who do not venture into the futures arena.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.