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After trading around the $40 per barrel level since early June, the NYMEX crude oil futures market has been spending more time below the pivot point than above since early September.
While inventories have declined and production is lower worldwide, the coronavirus continues to threaten demand for the energy commodity. Seasonality is also weighing on the price as we move towards the coldest period of the year in the northern hemisphere. Crude oil and product demand tend to decline during the winter months.
On the continuous NYMEX crude oil futures contract, technical support stands at the low from the week of September 8 at $36.13. Last week, the price traded to a low of $36.63 per barrel. Below there, the next level of support is at the mid-June low of $34.36 per barrel.
Meanwhile, the US election is now less than one month away. The contest is, among many things, a referendum on the future of US energy production. Over the past years, the US became the world’s leading producer of crude oil and natural gas. The potential for a significant shift in policy starting in 2021 could cause lots of volatility in the crude oil futures market over the coming weeks.
The ProShares Ultra Bloomberg Crude Oil (UCO) and its bearish counterpart the ProShares UltraShort Bloomberg Crude Oil ETF (SCO) are leveraged products that move higher and lower with a portfolio of NYMEX crude oil futures contracts.
The weak season could send the price for a test between $30 and $35 per barrel
The winter months can be a bearish time for the oil market. Gasoline demand tends to decline during the coldest months of the year. During challenging periods, oil tends to drop during the later months.
As the chart highlights, oil continued to fall in late 2008, reaching a bottom in December during the Global Financial Crisis. In late 2014, the energy commodity plunged late in the year, and in 2018, we witnessed the same bearish price action.
Aside from seasonal weakness, crude oil faces a demand decline because of the coronavirus pandemic and its second wave over the coming weeks and months.
The daily chart of November NYMEX crude oil futures illustrates that after spending most of the time over the $40 per barrel pivot point from June through late August, the energy commodity has been below that level since early September.
The critical technical support levels stand at $36.58, the September 8 low, and at $35.54, the bottom from mid-June. Crude oil traded down to a low of $36.63 on October 2 before its latest bounce back to the $40 level.
The total number of open long and short positions in the NYMEX crude oil futures market rose since mid-September as the price experienced selling pressure. Increasing open interest and falling price is typically a bearish sign in a futures market. Price momentum and relative strength indicators were sitting at neutral readings on October 6. Daily historical volatility moved to over 50% on October 6, close to the recent high. The price variance measure fell to a low of below 16% in August.
Crack spreads had been signaling weakness
Crack spreads measure the economics of processing a barrel of crude oil into oil products. The price action in crack spreads displays weak demand for gasoline and distillates.
The gasoline crack spread has been trending lower since April. At just over $11 per barrel, the processing spread was around the same level as last year at this time. However, at $40 per barrel, nearby crude oil futures are around $15 lower than in early October 2019.
The gasoline crack spread is seasonal, so it tends to weaken as the winter months approach. Distillates are more year-round fuels. The heating oil contract is a proxy for other distillates like jet and diesel fuels.
At $9.28 per barrel, the heating oil crack spread is substantially lower than at this time in 2019, when it traded to a low of $25.10 during the first week of October.
The overall weakness in crude oil processing spreads has been a sign of weak crude oil demand.
The election could be a bearish event for fossil fuel. Tropical storm Delta lifts the price.
The November 3 US election is a significant event for the future of US energy production. Technological advances in fracking and fewer regulations caused the US to become the world’s leading crude oil producer over the past years. According to the Energy Information Administration, US output reached a record high of 13.1 million barrels per day in March. Production was at 10.7 mbpd as of the week ending on September 25.
A sweeping victory by Democrats could change the landscape for US oil production. President Trump has been a staunch advocate for drill-baby-drill and frack-baby-frack. The opposition party favors alternative energy resources and limiting fracking. Therefore, the outcome of the election could dramatically change the US energy business in the coming years. If Democrats win the Presidency and a majority in the Senate, US crude oil production is likely to decline significantly.
The latest rally in the crude oil market came as Tropical Storm Delta strengthened into a Category 4 hurricane. As the storm heads for the Gulf of Mexico, the potential for disruptions in output and damage to energy infrastructure pushed the price of crude oil back to the $40 per barrel level on October 6.
OPEC is licking its chops for the long term
OPEC, Russia, and other world producers left their production cut level at 7.7 mbpd at the most recent meeting. The cartel and Russia are likely waiting to see election results from the US before making the next move.
Logic dictates that the world’s oil producers hope that Democrats win the election, which would hand the baton back to the cartel when it comes to controlling the international oil market. A ban on fracking in the US or even a substantial decline leading to less oil and gas output would strengthen OPEC’s position.
The US election has far-reaching consequences for the US and the world when it comes to energy. China and India, the most populous nations, will continue to require crude oil for years to come.
Trading oil with UCO and SCO
I expect lots of volatility in the crude oil market over the coming weeks as the US election approaches. The price of the energy commodity was leaning lower until the potential for a severe storm in the Gulf of Mexico pushed the price back to the $40 per barrel level. Once Hurricane Delta passes, we could see selling return to the crude oil futures market. The critical level of support is around $35 per barrel. Below there, we could see the price move back towards $30 during the coming months. Moreover, a second wave of the coronavirus would be bearish for the oil market.
The most direct route for a risk position in the WTI crude oil market is via the futures and futures options that trade on the CME’s NYMEX division. For those looking to trade crude oil without venturing into the futures arena, UCO and SCO provide alternatives.
The fund summary for SCO states:
Source: Yahoo Finance
The UCO product operates inversely, as it rises when the price of crude oil moves higher. SCO has net assets of $109.6 million, trades an average of almost 2.4 million shares each day, and charges a 0.95% expense ratio. November crude oil futures fell from $41.72 on September 18 to a low of $36.63 on October 2, or 12.20%.
The chart shows that SCO moved from $15.78 to $19.25 per share, or 22%, over the same period. November NYMEX futures recovered to a high of $40.86 on October 6, or 11.55%.
From October 2 through October 6, UCO rose from $24.51 to $29.28 per share, or 19.5%.
UCO has net assets of $1.54 billion, trades over 6.2 million shares each day, and charges the same 0.95% expense ratio. Both products hold a portfolio of three futures contracts and swaps to create leverage. UCO and SCO are only appropriate for short-term risk positions on the long and short sides of the crude oil market.
Crude oil bounced after trying the downside and returned to the $40 pivot point. While it may look like the energy commodity’s price is going nowhere fast, be prepared for lots of volatility over the coming week. Oil was leaning lower before the latest storm, which could mean that selling will return after Hurricane Delta passes.
Moreover, the lack of a stimulus package until after the election could trigger another round of risk-off selling in markets, and crude oil is no exception.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.