26 Aug

Will Crude Oil Resume Its $40 Path?

WRITTEN BY Rabindra Samanta

Last week, US crude oil prices fell 1.2% and settled at $54.17 per barrel. This week, the EIA inventory data, which is scheduled for August 28, should be an important factor in US crude oil prices. Moreover, any development around the US-China trade disputes could also impact oil prices.

On August 26, President Donald Trump announced that he would meet his Iranian counterpart for constructive talks at the right time. If the talks succeed, the supply in the oil market could rise, a factor that could send oil near the $40 level. Concerns surrounding the trade war have already kept US crude oil near the $50 level.

Will Crude Oil Resume Its $40 Path?

Could crude oil production rise?

In the week ended August 23, the oil rig count fell to 754, the lowest since January 19, 2018. A lower oil rig count could drag US crude oil production going forward, a positive development for oil prices. However, the rig count tends to follow US crude oil prices with a three- to six-month lag. If this pattern repeats, this month the oil rig count could bottom out.

On December 24, 2018, US crude oil active futures closed at $42.53 per barrel. It was the lowest closing level for active crude oil futures since August 10, 2016. The seven major shale plays are expected to add another 85,000 barrels per day in September on a month-over-month basis. This figure is based on the EIA’s Drilling Productivity Report released on August 12.

A slowdown in US drilling activities could hamper the revenues of the oilfield services stocks. In the week ended November 16, 2018, the oil rig count was at a multiyear high. Since that day, the oil rig count fell to 134. In this period, the VanEck Vectors Oil Services ETF (OIH) declined by 43.2%. OIH tracks oilfield services stocks. 

Brent-WTI spread: Is oversupply rising?

On August 23, the difference between the Brent and US crude oil active futures, or the Brent-WTI spread, was $5.17. On a week-over-week basis, the spread expanded $1.37. However, on August 19, the Brent-WTI spread fell to $3.53—its lowest level since July 20, 2018. Usually, a fall in US inventories or a rising supply glut outside the US could contract this spread.

In eight of the last 10 instances, the EIA reported a fall in US crude oil inventories in its weekly report. While this economic indicator suggests a robust economy in the US, Germany and Singapore’s economies contracted in the last quarter on a sequential basis. In July, the US unemployment rate was 3.7%, near the lowest level since 1969.

India’s auto sales have fallen significantly in the last few months. India is the third-largest consumer of oil in the world. A possible slowdown in demand outside the US could be underpinning this contraction in the spread.

US oil exports follow the Brent-WTI spread but with a lag. The contraction in the spread suggests that US oil exports could decline.

In the week ended August 16, US oil exports rose 0.12 MMbpd (million barrels per day). However, from the June 21 high of 3.77 MMbpd, these oil exports fell around 1 MMbpd. In this period, the Brent-WTI spread contracted 33.8%. A higher spread compensates for US oil exporters’ transportation costs. 

The contraction in the Brent-WTI spread could impact energy stocks such as ConocoPhillips (COP) and Pioneer Natural Resources (PXD). ConocoPhillips’s net income sensitivity with every $1 change in Brent/Alaskan North Slope crude oil prices per barrel is $155 million–$175 million. PXD’s oil output follows the stronger Brent crude oil prices.

Are bullish crude oil sentiments falling?

On August 23, US crude oil October 2019 futures settled $2.58 above the October 2020 futures. On August 16, this premium was $3.67. The contraction in the premium suggests a fall in oil’s bullish sentiments.

Moreover, prices usually decline with any contraction in the premium. Any expansion in the premium could lead to a rise in oil prices. The escalation in the US-China trade war on August 23 could explain the contraction in the spread. In the last week, US crude oil active futures fell 1.2%.

The US crude oil futures’ forward curve plays an important role for ETFs like the ProShares Ultra Bloomberg Crude Oil ETF and the United States 12-Month Oil ETF. An upward sloping forward curve could negatively impact the performance of these ETFs than oil’s price performance. However, on August 23, US crude oil futures for the next year settled in descending order, a positive development for these ETFs.

Price target

Based on the implied volatility of 31.5%, US crude oil active futures could close between $52.17 and $56.17 per barrel until August 30. The probability of reaching this price range is 68%. This model is based on the normal distribution of prices. However, with any progress in a US-China trade deal, crude oil prices could easily break the upper limit of our price forecast.

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