All Aboard the Oil Price Roller Coaster

All Aboard the Oil Price Roller Coaster

by | published December 27th, 2018

It’s a dark and stormy market.

Government shutdowns, geopolitical angst, protracted instability inside The Beltway, and outright market manipulation are combining to make this an unsettling time.

And after historic drops in oil prices, everybody is now looking for a floor to be established.

Given the end-of-year sales for tax purposes, low holiday volume, and institutional investor readjusting portfolios, even if a floor does show up it, probably will not register until sometime early next month.

Yesterday, both West Texas Intermediate, (WTI), the benchmark crude rate set in New York, and Brent, the more widely used oil trading standard set in London, spiked more than for any one session in well over a decade. WTI ended trading up by 8.7%; Brent by 8%.

However, we are still looking at this month coming in as the worst since the beginning of the credit bubble melt down ten years ago, and there is little reason to suspect that that sentiment will dramatically improve in the short-term.

Compounding the problem is the confluence of a triple whammy…

Raise Your Arms as the Drop Gains Speed

The first of these is the weakness in equities.

The second involves a fear that an inversion in the yield curve will prompt a further decline in bond prices.

This latter factor is somewhat overdone in my opinion. After all, those propounding this tsunami are the same guys who have correctly predicted five of the last two recessions. Don’t get me wrong, there are concerns on both fronts as an almost decade-long bull market comes under pressure.

The third element is what’s going on with oil prices.

Despite yesterday’s huge rally, both oil benchmarks remain well down for the month – 10.5% for WTI; 9.9% for Brent.

Additionally, the spread between the two remains above 15% of the difference as a percentage of WTI (the more accurate way of measuring it) and has been at double digits in each of the trading sessions since September 20.

I have discussed previously here in Oil & Energy Investor (at some length) why oil prices have been hammered into the ground. Some of the factors have emerged from underlying dynamics, but most have been the direct result of either overreaction based on no real data to back up it up or outright artificial manipulative moves.

As many Oil & Energy Investor readers will recall, I set up an algorithm to track the genuine price of oil – where the trade in wet barrels (actual consignments of physical oil available for delivery) would value the crude absent short, derivative plays, credit spreads, “phantom” barrels (booked but strategically appearing or disappearing in advance of settlement).

In essence, the price that oil ought to be valued at once the manipulation is stripped away.

Based on my calculations at close yesterday, the effective crude price (ECP) should be $54.50 for WTI and $66.20 for Brent. These are 17.9% and 21.5% higher than the market’s closing prices.

And that’s after yesterday’s huge gains.

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It’s a Long Ride – But Not Permanent

Let’s put this in perspective.

WTI and Brent reached their most recent highs on October 3. Since then, they have lost 39.5% and 37%, respectively. A very cursory, back of the envelope view would tell us that well over 40% of both benchmark dives have been artificially created.

Now that still leaves a genuine decline.

But there are two observations that are tantamount at this point:

First, the manipulation cannot be sustained in the face of rising prices. Because much of this requires a declining underling price to sustain profits, once the forward curve (extending prices out over time, generally using what is called the “NYMEX strip”) starts moving into contango.

That’s when the forward price of oil is higher than the current (or spot) price. If I actually buy physical oil, that would provide an advantage – I would be buying cheap and allowing a later sale at profit. But if I am running futures contracts – paper barrels – it would serve to contract estimated profits.

The result is those parlaying paper and wet barrels would start moving the near-term price higher.

As that trend develops, it requires an unraveling of shorts and related moves based on the need for prices to continue declining. The market price then increases acceleration.

Second, as is already emerging with oil-related stocks, the appreciation will move up well in advance of the market as a whole. This flows from the simple fact that the sector is already significantly oversold.

In other words, both observations mean we are in for a nice ride shortly.

We just need the dust to settle first and let the roller coaster come to a stop.



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  1. January 9th, 2019 at 07:56 | #1

    All of good

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