ERX: Crude Oil Pricing Power Now In The Hands Of OPEC, Russia
Summary
- OPEC’s decision reflects changing fundamental dynamics.
- Drill-baby-drill is dead.
- US production is falling, and that will continue.
- The end of the pandemic will cause demand to surge. Here are three signals that crude oil will continue to make higher highs.
- ERX is a trading tool for trend-following as the sector rotation continues.
- Looking for more investing ideas like this one? Get them exclusively at Hecht Commodity Report. Learn More »
Last week, nearby NYMEX crude oil eclipsed the early January 2020 high and critical technical resistance level at $65.65 per barrel. Just five months earlier, on November 2, 2020, the energy commodity traded to a low of $33.64.
The price of crude oil has nearly doubled as the bullish stars lined up for the energy commodity. Since 2018, a roaring stock market did little to support the prices of energy-related shares. The leading US oil companies and related businesses watched as their share prices evaporated. When stocks rallies, they did not follow. When stocks corrected lower, the oil companies led the way on the downside. In March 2020, when risk-off selling hit markets across all asset classes, traditional energy stocks plunged. After a recovery, the fell again in early November when Democrats captured the White House and both houses of Congress with promises of addressing climate change by ending production and consumption of fossil fuels.
Meanwhile, sector rotation in the stock market can be a powerful force. In a sell the rumor and buy the news reaction, we have seen a substantial recovery in oil-related shares as the price of the energy commodity continues to climb. The oil market seems to be telling the world, be careful what you wish for as the process of ending dependence on hydrocarbons could lead to a prolonged period of price appreciation.
The Direxion Daily Energy Bull 2X Shares (NYSEARCA:ERX) is a short-term trading tool that holds a turbocharged position in many of the leading US oil and oil-related companies.
OPEC’s decision reflects changing fundamental dynamics
Last Thursday, the oil ministers from OPEC and the Russians agreed to keep oil production steady, meaning that the output cuts addressing the global pandemic will remain mostly in force. The news came as nearby NYMEX WTI crude oil futures remained above the $60 per barrel, and Brent futures on the Intercontinental Exchange moved towards $65 for the first time since January 2020.
Russia and Kazakhstan will modestly increase their production while the other cartel will continue to produce at the same level. Saudi Arabia intends to extend its voluntary one million bpd production cut into April. The Saudi oil minister said, “At the risk of sounding like a stuck record, I would once again urge caution and vigilance.” While the comments appear to address the ongoing demand threat posed by the global pandemic, the cartel’s power is growing. A higher petroleum price is OPEC’s goal as the cartel would rather sell fewer barrels at a higher price than more at a lower price.
In the aftermath of OPEC’s latest decision, crude oil prices rose.
Source: CQG
As the chart highlights, nearby NYMEX futures rose above the 2020 $65.65 high to a peak of $66.42 at the end of last week and to $67.98 on March 8, over the level of minor technical resistance at the April 2019 $66.60 high. The next target is the October 2018 $76.90 high, which could be a technical gateway to the $100 per barrel level. Crude oil has not traded in the triple digits since mid-2014.
Source: CQG
May Brent futures stopped short of the January 2020 high at $71.99, rising to $71.36 on March 8. As the chart illustrates, above the technical resistance level, upside technical targets stand at $75.59 and $86.72, which is the gateway to $100 per barrel Brent crude oil.
There is a lot more to OPEC’s decision than fears over demand created by COVID-19. The bottom line is that the Middle East and Russia view the price trend in crude oil as an opportunity to squeeze the United States as a payback for the past years when shale oil diminished the cartel’s pricing power.
Drill-baby-drill is dead
In the aftermath of the latest OPEC session, Saudi Energy Minister Prince Abdulaziz bin Salman taunted the United States saying, “Drill-baby-drill” is gone forever.” As the oil price rises, the potential for increased production from Texas, Oklahoma, and North Dakota is a lot lower in 2021 than it was over the past years.
The reaction of oil prices to Saudi Arabia’s surprise production cut early this year and the latest OPEC decision shows that the energy commodity is now a lot more sensitive to the cartel’s policy decisions. The pricing power baton has shifted back to the Middle East and Russia in the aftermath of the 2020 US election.
On his first day in office, President Joe Biden canceled the Keystone XL pipeline project that carries petroleum from the oil sands in Alberta, Canada to Nebraska and other US pipeline destinations leading to Cushing, Oklahoma, the delivery point for NYMEX crude oil futures. The Biden administration immediately rejoined the Paris Climate Accord in a symbolic move that it will be aggressive in addressing climate change. With his party’s left flank opposed to any fracking, the President supports a far stricter regulatory environment for the US energy industry over the coming years.
Technological advances have caused the cost of producing crude oil to decline; increased regulations will erase producers’ benefits. While the administration’s energy policy favors alternative, clean energy sources for producers and consumers, it will take years, if not decades, to replace crude oil. Meanwhile, after decades of an energy policy that worked to achieve independence from the Middle East, the Saudis, Russians, and other producing countries smell blood in the water. The US production is falling, which means it will need to source the energy commodity via imports. If the Saudis are correct and “drill-baby-drill” is dead under the Biden administration, they are likely to ring the cash register with their oil production if they continue to drive the price higher.
US production is falling, and that will continue
In March 2020, US daily crude oil output reached an all-time high of 13.1 million bpd under the Trump administration’s energy policies. According to the Energy Information Administration, as of February 26, US production stood at ten million bpd, a decline of 23.7% over the past year.
The substantial shift in US policy, with consistent pressure from progressive Democrats, means that US output is unlikely to reach the March 2020 level any time soon, if ever again. The Saudis are making an aggressive bet that US climate change policy will be a financial gift that keeps on giving over the coming years.
WTI and Brent crude oil prices have not traded at the $100 per barrel level since mid-2014. The Saudis and Russians blame the US shale producers for their financial woes. Payback is now within their reach.
The end of the pandemic will cause demand to surge- Three signals that crude oil will continue to make higher highs
Vaccines creating herd immunity to COVID-19 will be a shot in the arm for the global economy. After a year of social distancing guidelines in the US, an end to the pandemic is likely to create an economic boom. People will return to work, travel, and venture out more during the coming months than over the past year. Oil demand is likely to surge. We have already seen signs that energy demand is surging across the US.
The crude oil market has become far more sensitive to events in the Middle East and OPEC production decisions. In January, Saudi Arabia’s decision to add another one million bpd to its production cut caused the price to move higher. Last week’s OPEC+ decision to lead cuts largely intact pushed NYMEX crude oil over the $65.65 2020 peak. Moreover, an attack on Saudi production the appeared to be by Iranian-backed rebels sent within 63 cents of the January 2020 high when the May contract reached $71.36 per barrel.
Crack spreads have been trending higher, indicating growing demand for oil products in the wake of the global pandemic.
Source: CQG
Gasoline refining spreads rose from $6.43 in late November to over the $21 per barrel level as of March 8.
Source: CQG
The heating oil crack spread, a proxy for other distillates, moved from $6.44 in late September 2020 to over the $15 per barrel level on March 8.
While the stock market and some other commodities have run into selling, crude oil continues to make higher highs. Gold continues to correct, copper and lumber fell from their latest highs, and other commodities have been consolidating. Crude oil made another new and higher high on March 8. The energy-related stocks have been one of the strongest stock market sectors since late October.
Source: Barchart
The XLE, which holds many of the leading US oil-related companies, recovered from $26.98 in late October to $53.85 on March 8, as it nearly doubled. Over the same period, NYMEX April crude oil futures rose from $35.53 to $67.98 or 91.33%. The S&P 500 Index rose from 3,233.94 in late October to a high of 3,950.43 on February 16 when it turned lower. At the high, the stock market index was 22.2% higher. The energy-related stocks outperformed both crude oil and the stock market since late October.
ERX is a trading tool for trend-following as the sector rotation continues
Markets rarely move in a straight line. Even the most aggressive bull markets suffer corrections. However, the trend in crude oil stocks remains higher as of March 8. The Direxion Daily Energy Bull 2X Shares (ERX) is a short-term product for those looking to turbocharge upside returns in US crude oil and energy-related stocks. The top holdings and fund summary of the ERX product include:
Source: Yahoo Finance
ERX has net assets of $626.20 million, trades an average of over 5.5 million shares each day, and charges a 1.06% expense ratio.
Source: Barchart
From late October through March 8, the ERX product rose from $7.48 to $28.15 per share or 276.34%. For those looking for a correction in US energy-related shares, the ERY product operates inversely.
The trend is always your best friend in markets. As of March 8, it remains higher in crude oil and energy stocks. The shift in US energy policy that hands pricing power back to OPEC+ remains bullish for the price of the energy commodity that powers the world.
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This article was written by
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.
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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
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