Oil Continues To Float In A Range

Summary

  • A brief rally on the back of the Middle East interrupts oils range trading.
  • Trade is a critical issue.
  • Another OPEC cut could be on the horizon.
  • Range trading from the long side has been the optimal approach.
  • Trading with UCO on dips has been a winning strategy.
  • Looking for more stock ideas like this one? Get them exclusively at Hecht Commodity Report. Get started today »

In 2018, the price range in the NYMEX crude oil futures market was $34.54. During the final three months of last year, the price traded on both sides of the range. The high came in early October at $76.90 and the low in late December at $42.36 per barrel.

In 2019, we have not seen the same degree of price volatility. The low came at the start of 2019 at $44.35 and the high in April at $66.60 per barrel. The trading range of $22.25 is significantly tighter than in 2018. However, since mid-January of this year, the range was from $50.38 to $66.60 or $16.22, which is less than half last year's trading band.

At the end of last week, nearby December NYMEX crude oil futures were trading at $55.60 per barrel after the price bounce off the most recent low at $50.89 on October 3. Throughout October, crude oil has been working its way high, but it continues to float within the trading range that has been in place for most of this year. Buying price dips down towards the $50 per barrel level has been the optimal approach to the crude oil market throughout 2019. I continue to believe that trading crude oil from the long side of the market on price weakness is the optimal approach to the future market. If the price breaks below $49 per barrel, I would go with the flow with a short position or move to the sidelines after grinding profits by buying on dips throughout this year.

The most direct route for a risk position on the long or short side of the WTI crude oil market is via the futures and futures options that trade on the NYMEX division of the CME. For those who do not venture into the futures arena, the ProShares Ultra Bloomberg Crude Oil product (NYSEARCA:UCO) and its bearish counterpart (SCO) provide an alternative. UCO and SCO are double-leveraged products that magnify the price action in the NYMEX crude oil futures market on a short-term basis.

A brief rally on the back of the Middle East interrupts oils range trading

For the most part, 2019 has not been an exciting year for the crude oil market. The price began the year by climbing to the high at $66.60 on the nearby NYMEX futures contract in April, but it ran out of upside steam and fall to just above $50 per barrel in June and August. In mid-September, the drone attack that knocked out half of Saudi Arabia's daily oil production, which amounts to 6% of the world's supplies, cause a price spike to the upside.

Source: CQG

The daily chart of December futures highlights that NYMEX futures closed on Friday, September 13, at $54.57 per barrel. The continuous contract settled at $54.82 that day. After the attack on Saturday, September 14, the price spiked to a high at $62.75 on September 16 and $63.38 on the nearby NYMEX futures contract. The move of around 15% quickly ran out of steam. By the end of September, the Saudi's returned output to the pre-attack level and the price of the December futures were back at a low at $50.89 per barrel on October 3.

The spike higher interrupted the range trading in the oil futures market, briefly. Meanwhile, just as crude oil ran out of buying in mid-September on the highs, it ran out of selling in early October and has rallied steadily throughout the month.

Trade is a critical issue

The trade war between the US and China has weighed on global economic growth. In the most recent GDP report, China reported the lowest increase in thirty years at 6%. Crude oil is a commodity that is highly sensitive to the overall health and wellbeing of the global economy. Economic weakness in China, the world's second-largest economy and most populous nation, has been bearish for the prices of many commodities, and crude oil is no exception. As economic growth declines, the demand for energy tends to fall.

The bullish price action in the oil market throughout October is likely more of a commentary on a return of optimism over trade than the fundamentals of the crude oil market. Production in Saudi Arabia is back at the pre-attack level. US output has increased to 12.6 million barrels per day, which makes the US the world's leading producer of the energy commodity. And, since the mid-September attack, the situation in the Middle East has been almost eerily quiet when it comes to Iran.

On the trade front, the potential for a "phase one" deal between the US and China has injected optimism into markets, which has caused the price of crude oil to recover. At the close of business on Friday, October 25, the price of December NYMEX futures was at $56.66 per barrel with Brent December futures at $62.02 per barrel.

Another OPEC cut could be on the horizon

Saudi Arabia, the most influential member of the international oil cartel, has told the world that they favor a trading range in Brent crude oil between $60 and $70 per barrel. At just over $62 last Friday, the energy commodity is near the bottom end of the desired band.

Source: CQGThe chart of January Brent futures, which rolled from December this week, shows that aside from the move that followed the drone attack, the price has spent most of its time below the $60 per barrel level. The low level of crude oil is a problem for Saudi Arabia on two fronts. First, to balance the Kingdom's budget, the breakeven on Brent crude oil is around the $80 per barrel level. And, perhaps more importantly, Crown Prince Mohamed bin Salman had been talking with financial institutions about an initial public offering of Aramco once again. While the valuation remains a sticking point, the crown jewel of the Saudi economy would be the largest IPO in history and create a public company with the highest market cap. Aramco is a highly profitable business, and the Saudis hope to sell at least a 5% stake in the company at a valuation of $1.5 trillion or higher to raise capital for its sovereign wealth fund. The Saudis wish to diversify their economy away from dependence on petroleum, but ironically, the funds to accomplish the goal must come from the oil market.

The oil ministers of OPEC will gather for their biannual meeting on December 5 and 6 in Vienna, Austria. The Saudis and Russians, who have become increasingly influential non-members of the cartel since 2016, will decide on production policy for the first half of 2020. At its last meeting, OPEC extended its current 1.2 million barrel per day production cut into 2020. However, with the price of Brent crude oil trading at or below the low end of the sweet spot range for the Saudis, a further cut in output could be on the horizon in early December. A deeper cut and lower output quotas would support the price of the energy commodity.

Range trading from the long side has been the optimal approach

Stripping out the rally that followed the drone attack, nearby NYMEX crude oil has traded in a range from $50.52 to $59.32 since late July. During the same time, the trading band sans the price spike in Brent has been from $55.45 to $63.44

Source: CQG

The weekly chart of NYMEX WTI futures illustrates that each time the price fell below $51 per barrel, it created a highly profitable buying opportunity. The first move came in early June when the low at $50.60 gave way to a move to a high at $60.94 during the week of July 8. After a move to $50.52 in early August, the price rallied to the post-attack high at $63.38 in mid-September. The most recent decline to $50.99 during the week of September 30 has taken the price to a high of $56.92 per barrel during the week of October 21. The bottom line is that dips in the oil market have repeatedly offered market participants profitable buying opportunities.

Open interest in the NYMEX futures market at the 2.048 million contract level has been steady throughout most of 2019. Price momentum and relative strength indicators on the weekly chart are on either side of neutral at over $55.60 per barrel at the end of last week. Weekly price volatility at just over 29% has been rising from a low at 21.28% in late September. The weekly trading ranges in the crude oil market have been trending wider since mid-September.

Trading rather than investing in the crude oil futures arena has been the optimal approach to the energy commodity.

Trading with UCO on dips has been a winning strategy

Crude oil is currently in no-where land in the middle of its trading range at between $56 and $57 per barrel on the nearby NYMEX futures contract. The futures arena is the most direct route for a trading position in crude oil. However, the ProShares Ultra Bloomberg Crude Oil product and its bearish counterpart SCO provide an alternative for those who do not venture into the highly leveraged and volatile futures arena. UCO and SCO are double-leveraged products that magnify the daily price action in the crude oil market. The most recent top holdings of UCO include:

Source: Yahoo Finance

As the chart shows, UCO holds swap and futures positions to create double leverage. SCO operates inversely as it holds swaps and futures to create downside exposure.

UCO has net assets of $301.56 million, while SCO's stand at the $94.92 million level. Over 4.05 million contracts of UCO change hands each day while SCO averages just under 2.6 million contracts. Both products charge an expense ratio of 0.95%.

The price of December NYMEX crude oil rallied from $50.89 on October 3 to the most recent high at $56.92 on October 28, a recovery of 11.85%. Before that, the December contract fell from $62.74 on September 16 to the October 3 low, a move of 18.9%.

Source: Barchart

The recent rally in the crude oil market took UCO from $14.28 to $17.87 per share or 25.1% higher., which was over double the percentage price move in the NYMEX futures market.

Source: Barchart

The move from the mid-September peak to the early October low took SCO from $12.12 to $18.35 per share or 51.4% higher, which was more than twice the percentage move to the downside in the NYMEX futures market.

The price action in the crude oil futures market continues to float in a trading range. We could see another selloff before the OPEC meeting, which is a little over one month away. The potential for a deeper production cut will rise if pressure returns to the oil futures market, and the price of Brent futures drop below the $60 per barrel level. UCO and SCO are excellent short-term tools for those market participants wishing to trade the range in the oil market without venturing into the futures arena.

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This article was written by

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Andy Hecht is a sought-after commodity and futures trader, an options expert and analyst. He is the #2 ranked author on Seeking Alpha in both the commodities and precious metals categories. He is also the author of the weekly Hecht Commodity Report on Marketplace - the most comprehensive, deep-dive commodities report available on Seeking Alpha.

Andy spent nearly 35 years on Wall Street, including two decades on the trading desk of Phillip Brothers, which became Salomon Brothers and ultimately part of Citigroup.

Over the past two decades, he has researched, structured and executed some of the largest trades ever made, involving massive quantities of precious metals and bulk commodities.

Andy understands the market in a way many traders can’t imagine. He’s booked vessels, armored cars, and trains to transport and store a broad range of commodities. And he’s worked directly with The United Nations and the legendary trading group Phibro.

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“I have a vast Rolodex of information in my head… so many bull and bear markets. When something happens, I don’t have to think. I just react. History does tend to repeat itself over and over.”

His friends and mentors include highly regarded energy and precious metals traders, supply line specialists and international shipping companies that give him vast insight into the market.

Andy’s writing and analysis are on many market-based websites including CQG. Andy lectures at colleges and Universities. He also contributes to Traders Magazine. He consults for companies involved in producing and consuming commodities. Andy’s first book How to Make Money with Commodities, published by McGraw-Hill was released in 2013 and has received excellent reviews. Andy held a Series 3 and Series 30 license from the National Futures Association and a collaborator and strategist with hedge funds. Andy is the commodity expert for the website about.com and blogs on his own site dynamiccommodities.com. He is a frequent contributor on Stock News- https://stocknews.com/authors/?author=andrew-hecht

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.

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