Crude Oil Outlook:
- In energy markets, prices are reflecting a battle of the fundamentals: short-term (cold spell in US) versus long-term (significant supply on sidelines).
- Crude oil prices are nearing the January 2020 high, and in doing so, are readying a test of the descending trendline from the July 2008 (all-time high) and June 2014 highs. A significant bottom may be in place soon.
- Recent changes in retail trader positioning gives us a bullish bias towards crude oil prices.
Crude Oil Prices Near 2020 High
In energy markets, prices are reflecting a battle of the fundamentals: short-term versus long-term. In the short-term, a cold spell that has swept across the midwestern US has buffeted energy markets to their highest levels since January 2020. A crippled US energy supply has help bolster the supply-demand imbalance that’s been the driving force in markets for the past several months.
Crude oil prices are climbing a wall of worry long-term, however, as it appears that US shale producers are not going to be able to return to their pre-COVID output until late-2022. A recent Reuters report shared the following anecdote from an anonymous OPEC delegate: “US shale is the key non-OPEC supply in the past 10 years or more…If such limitation of growth is now expected, I don’t foresee any concerns as producers elsewhere can meet any demand growth.”
This is an important development for energy markets. OPEC+ has already scaled back their production cuts from 8.2 million bpd to 7.7 million bpd starting on January 1, 2021. In December 2020, a survey produced by the Dallas Fed suggested that the breakeven price for new wells varies between $46 and $52 per barrel. Alas, this may no longer be the case.
Crude oil prices are now contending with significant technical resistance now that it has been unburdened by deadweight fundamentals. The gains are now more sustainable as the fundamental backdrop has evolved to limit concerns about supply returning rapidly in 2020 or even 2021.
Crude Oil Price Technical Analysis: Daily Chart (January 2020 to February 2021) (Chart 1)
Crude oil prices have been trading in an ascending channel over the past four months, rallying over +87% from the November 2020 low (at the time this report was written). The futures market has already touched the closing high for 2020, but still has a little way to go to reach the absolute high for the year (65.65).
It’s worth noting that the rally may be getting ‘long in the tooth,’ even with momentum so strong. Crude oil prices are also nearing channel resistance, as well as a descending trendline dating back to the all-time high. Looking at daily Slow Stochastics, which have reached their highest level since July 2020, we may be entering a period where the rally slows and shifts into a period of sideways consolidation.
Crude Oil Price Technical Analysis: Weekly Chart (December 2009 to February 2021) (Chart 2)
Crude oil prices are nearing the January 2020 high, and in doing so, are readying a test of the descending trendline from the July 2008 (all-time high) and June 2014 highs. Achieving 65.65 would be a meaningful bullish technical development. A significant bottom may be in place soon for crude oil prices.
Oil Prices and Oil Volatility...Align?
Crude oil prices have a relationship with volatility like most other asset classes, especially those that have real economic uses – other energy assets, soft and hard metals, for example. Similar to how bonds and stocks don’t like increased volatility – signaling greater uncertainty around cash flows, dividends, coupon payments, etc. – crude oil tends to suffer during periods of higher volatility.
Heightened uncertainty in financial markets due to increasing macroeconomic tensions decreases theoretical demand for energy; signs that the global economy is recovering from the coronavirus pandemic reduces uncertainty, and thus, volatility.
OVX (Oil Volatility) Technical Analysis: Daily Price Chart (February 2020 to February 2021) (Chart 3)
Oil volatility (as measured by the Cboe’s gold volatility ETF, OVX, which tracks the 1-month implied volatility of oil as derived from the USO option chain) was last spotted trading at 40.18. Oil volatility remains far below the yearly absolute high (incidentally the all-time absolute high) set on April 21 at 517.19, and still considerably below the yearly closing high (incidentally the all-time closing high, also established on April 21) at 325.15. Oil volatility is back at levels seen throughout 2019; the situation has been and appears to be poised to remain stable, as has been the case in the second half of 2020.
However, with volatility on the rise, and crude oil prices continuing their climb, the typical correlation between oil and volatility has broken down. The 5-day correlation between OVX and crude oil prices is +0.89 while the 20-day correlation is -0.26; and one week ago, on February 17, the 5-day correlation was +0.90 and the 20-day correlation was -0.66.
IG Client Sentiment Index: Crude Oil Price Forecast (February 24, 2021) (Chart 4)
Oil - US Crude: Retail trader data shows 44.12% of traders are net-long with the ratio of traders short to long at 1.27 to 1. The number of traders net-long is 6.66% higher than yesterday and 1.64% lower from last week, while the number of traders net-short is 6.75% higher than yesterday and 1.76% higher from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests Oil - US Crude prices may continue to rise.
Traders are further net-short than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger Oil - US Crude-bullish contrarian trading bias.
--- Written by Christopher Vecchio, CFA, Senior Currency Strategist
