Oil Rally Running Out of Fuel

For over a century Oil has been the lifeblood of the global economy, essential for transportation, power generation, infrastructure, drugs, and plastics. Despite Government efforts to restrict production of fossil fuels, their consumption continues to grow with no end in sight. The demographics of an aging labor supply and Government anti-Fossil fuel mandates have served to limit the growth rate of Oil production and combustion engines, yet forecasts call for ever more consumption and elevated pricing, barring a global economic contraction. The OPEC+ cartel has taken advantage of the tight supply and demand curves and strong economy by removing 2.5 million barrels a day of Oil over the past year to boost Crude Oil $92 this week. Saudi Arabia is the quarterback of OPEC+ that the Biden administration has cast as a pariah, so no production favors to bring down energy prices can be expected there until a Recession is imminent. Unless unemployment pushes beyond 4.5% in 2024, we would expect that a firm floor has been established above $70 a barrel.  A year ago, we had forecasted a seasonal swoon in Oil down to the mid-$60’s over the winter. That target was reached last March at $64. The negative trends reversed in April with a Bullish seasonality, a stronger than forecast economy and a 7 year high in Commercial trader (see chart) net long position hedging. These conditions foretold of an Oil rebound back to the upper end of its range in the $90’s this year. The 44% Oil rally from the April lows is setting the table for a September or October peak before seasonality and weaker GDP data overwhelm OPEC’s chokehold and send Oil back below $80 over the winter months.

The technical picture on the weekly Oil chart has been Bullish since the positive stochastic divergence with price last March and again in June. The pattern of 12-to-13-week rallies and a DeMark momentum overbought (13) signal provide a window of expectations for a topping pattern. 

The technical picture from the daily chart perspective shows that an embedded overbought RSI momentum indicator combined with seasonality and swing projections favored a temporary top in the low $90’s this week. In a recent interview, we did not favor investing new money in energy stocks at this time due to overbought risk with Oil trading in the upper end of our expected trading range ~$90’s to low $100’s. Short term, however, there is still time for a brief pullback into the $80’s and one more final new high for the year. Expect modestly lower prices by Christmas.

The good news for Bulls is that Oil, Gasoline, Heating Oil and Distillate inventories remain quite low. Oil and distillate stockpiles should increase by the Holidays as demand slows and high energy prices encourage more production. The outlook is for trading range with the current price of $90 residing above the midpoint. 

Countering the Saudi and Russian effort to create tight energy supplies are the efforts of Iran, Brazil and the US who continue to increase production. The US will reach a record annual Oil output level this year.

US Natural Gas production and exports lead the world and have kept energy prices artificially suppressed. They are also the primary reason US CO2 emissions keep falling. Natural Gas has a natural surplus as it must be extracted as a byproduct of Permian Basin Oil drilling. Low Oil inventories lead to high Oil prices, which lead to more Oil drilling and an undesirable excess of Natural Gas. This is often why Natural Gas prices fall due to expanding gluts while Oil prices rise. Oil prices should cool, and Gas export capacity will grow sufficiently in Q1 2024 to provide a rare breakout higher in Natural Gas prices. Seasonal lows in February or March 2024 may provide a good entry for upside hedges next year. Europe will increasingly soak up excess US LNG exports as they separate from Russia.

If the global economy avoids a hard economic landing in 2024, then the US will struggle to add enough new Oil supply during an extended economic expansion. Increasing inventories next year will also be difficult since President Biden drained our Strategic Petroleum Reserve (SPR) by almost 50%. The US Government will be forced to be a major Oil buyer should Oil test $70 or lower again, providing a price floor. However, due to an election season that is in full swing, Biden will also announce a further drawdown of SPR Oil reserves should Crude Oil surpass $100/barrel. This political reality provides a general trading range for Oil, barring a deflating economic recession with high unemployment.

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