What’s Weighing on the Outlook for Oil?

Oil and SPY impacted by slowdown concerns

On July 8, US crude oil prices rose 0.3% and settled at $57.66 per barrel. In the trailing week, US crude oil prices fell 2.4%. Between July 1 and July 8, the S&P 500 Index (SPY) fell 0.5%. The concerns surrounding a global slowdown impacted both oil and the S&P 500 Index. Energy stocks account for ~5.2% of SPY.

What’s Weighing on the Outlook for Oil?

Slowdown fear and US oil output are suppressing Iran factor

As of July 9 at 5:30 AM ET, US crude oil active futures have risen just 17 cents. Concern for a slowdown in the global economy along with the US-China trade war has dampened the oil outlook. The IEA Oil Market Report on July 12 will be important in this regard.

On July 8, the US ten-year Treasury constant maturity minus three-month Treasury constant maturity yield spread was at -21 basis points, near its lowest level since late April 2007. On March 22, the US ten-year Treasury constant maturity minus three-month Treasury constant maturity yield spread fell just below zero for the first time since August 8, 2007. In the last three decades, when the yield spread turned negative, a recession started the next year. Oil is a growth-driven asset. Oil would likely be impacted negatively by any weakness in the global economy.

Moreover, the slowdown fear and higher US crude oil output might have suppressed the Iran factor, which could help oil’s rise. Iran tension with Western countries could escalate due to the current circumstances. With the United Kingdom seizing an Iranian oil tanker and Iran breaching the uranium enrichment limit set under the nuclear deal, the situation could deteriorate. While analysts see little chance of a direct conflict with Iran, problems for oil tankers passing the Strait of Hormuz can’t be ruled out. Last month, an attack on oil tankers in that region helped oil prices to rise.

Key technicals

On July 8, US crude oil prices were 1.2%, 2.2%, and 1.6% below their 50-day, 100-day, and 200-day moving averages, respectively. Moreover, on July 5, the 50-day moving average fell below the 200-day moving average for the first time since May 7. This crossover of shorter-term moving averages below longer-term moving averages is called the “death cross.” In technical terms, the death cross is followed by weaker asset prices. This week, the EIA inventory data will likely be important for US crude oil prices, which were 3.6% above their 20-day moving average.

Oil rig count

Last week, the oil rig count fell by five to 788, its lowest level since February 2, 2018. The rig count tends to follow US crude oil prices with a three to six-month lag.

In February 2016, US crude oil prices fell to the lowest closing level in 12 years. Between February 11, 2016, and July 8, 2019, US crude oil active futures rose 120%. The oil rig count reached a 6.5-year low of 316 in May 2016. Between May 27, 2016, and July 5, 2019, the oil rig count rose ~149.4%. Between May 27, 2016, and June 28, 2019, US crude oil production rose ~39.7%.

Has the oil rig count bottomed out?

On December 24, US crude oil active futures settled at $42.53 per barrel, the lowest closing level since August 10, 2016. Based on the pattern we saw above, the oil rig count could keep falling until at least June. Last week, the oil rig count was at the lowest level since February 2, 2018. In this quarter, the US crude oil production might increase, an important factor that might kill any upside in oil prices. For the week ending June 28, US crude oil’s weekly production was at 12.2 MMbpd (million barrels per day), which is near its record high. In the Drilling Productivity Report released on June 17, the EIA estimated that seven major US shale regions will add 70 thousand barrels per day in July compared to June.

According to the EIA, the new-well oil production per rig from the major seven shale regions could rise by 2% in July compared to the previous month. On a year-over-year basis, this rig-weighted average has risen 5.8%. Rising rig efficiency because of technological advancement is an important factor behind higher oil output even with lower rig count.

Oilfield services stocks

Since the US oil rig count hit a multiyear high of 888 on November 16, the VanEck Vectors Oil Services ETF (OIH) has fallen 24.2%. Schlumberger (SLB), Halliburton (HAL), and Transocean (RIG) have fallen 17.3%, 28.4%, and 36.5%, respectively. OIH has 44% exposure to these stocks. Any rise in US oil drilling activities could boost these oil services stocks. Between November 16, 2018, and July 8, 2019, the oil rig count fell ~11.3%. If the oil rig count bottoms out, it might benefit these oilfield services stocks.