Specious Argument

I am raising by ten dollars my September forecast for West Texas Intermediate (WTI) oil price to range between $80 to $100 per barrel.

Figure 1: WTI Confidence Intervals

To some people, my range might seem too wide. In reality, it is not. For example, on Thursday, September 28, WTI touched $95, which exceeded my prior range of $70 to $90 per barrel. We can also look at the latest price forecast from the U.S. Energy Information Administration’s “Short-Term Energy Outlook,” which is shown in figure 1. We see that prices often move significantly in a brief period and that the futures price range is wide. For those wanting to know how the upper and lower bounds were determined, please see the following EIA PDF document: “Short-Term Energy Outlook Supplement: Energy Price Volatility and Forecast Uncertainty.”

Figure 2: thinkorswim’s Quotes for WTI Futures and Options –August 27, 2023.

My main purpose for establishing ranges is to document my thinking for my own positions. I have options on a few oil equities, and forming an opinion on near-term oil prices allows me to create or adjust my positions as required.

I was surprised by the strength of oil during the last month. A month ago, I thought it was unlikely that oil would reach $100 per barrel this year. A screenshot from thinkorswim showed some option Greeks for WTI expiring in January and February. I have included that screenshot again in figure 2. Please see my prior post where I discussed how to interpret delta for assessing the likelihood of oil prices exceeding or touching a strike price.

Figure 3: thinkorswim’s Quotes for WTI Futures and Options –September 30, 2023.

See figure 3 where I have included an updated screenshot taken on Friday, September 29, at about 12:11 p.m. Mountain Time. Note that the December $100 call price has increased from $0.33 to about $1.05. Similarly, the January $100 call price has increased from about $0.49 to about $1.25. Had a person been extremely bullish on oil, buying either of these calls would have been extremely profitable. Also, the January and February deltas are 0.1737 and 0.1834, respectively. That implies that the odds of WTI closing at or above $100 in January or February expiration is about 17 and 18 percent, respectively. Given that the spot price was $90.60, those odds seem low. Of course, the WTI is in backwardation, so the January and February futures oil prices were $86.89 and $85.21, respectively when the screenshot was taken.

Various pundits are now calling for high prices, though many seem to suggest that while $100 per barrel is possible or likely, going much higher would take some other extraordinary development. For those with a Bloomberg subscription, you can view Amrita Sen’s commentary on September 27 where she forecasts $100 by Halloween. Amrita Sen is the founder and director of research at Energy Aspects, a highly respected energy consulting firm.

@ea_amrita tells @Bloomberg Surveillance that we will continue to see a crude oil supply gap in the medium term in her latest interview. Access here 👉 https://t.co/MECFhknuyC – interview starts @ 1:53:28 mark 🛢 📈 #OOTT pic.twitter.com/JDyemkLy1P

— Energy Aspects (@EnergyAspects) September 28, 2023

A Bloomberg screenshot of Energy Aspect’s note says the following:

We do not see crude prices letting up in the near term, with $100 still in sight for Brent. Crude fundamentals have become strong enough that the macro story is no longer sufficient to drive price action. Instead, crude is starting to drive the macro view.

While she references Brent prices, WTI prices are currently two or three dollars less than Brent prices.

I hope oil prices do not go above $100 per barrel because it seems that whenever oil prices go too high, they come crashing down later. Oil prices above $100 per barrel will cause economies to slow and consumers to reduce consumption. Instead, I would prefer that oil prices stay in the high $80s to low $90s. My preference, however, means nothing.

The next few months in the oil markets will be interesting and challenging. Again, my forecast for October is for WTI oil price range to $80 to $100 per barrel.

For September, I am maintaining my August forecast for West Texas Intermediate (WTI) oil prices ranging between $70 and $90 per barrel.

OPEC+ will likely extend its production cut into October. Although It may reduce its cut somewhat, I expect that cut to remain at its current levels at roughly one million barrels per day from Saudia Arabia and five hundred thousand barrels per day from Russia.

Reuters’s August 25, 2023, article “Russia’s oil exports via western ports slightly up in August despite pledged cuts” questions whether Russia is completely adhering to their cuts.

MOSCOW, Aug 25 (Reuters) – Crude oil loadings from Russia’s western ports in August are seen slightly higher from July despite Moscow’s pledge to cut oil exports by 500,000 barrels per day, according to traders, shipping data and Reuters calculations.

The loadings remain well below a four-year export peak achieved in May, the data shows.

…

But as Russia has not provided the baseline for its supply reduction, the rise of loadings in August from July does not mean Moscow is not fulfilling its pledge.

Although the voluntary OPEC+ cuts by Saudi Arabia and Russia have tightened physical markets, oil prices have not moved very much at all. Some point to increased production by Iran and China tapping its strategic petroleum reserves. Others point to China’s and Europe’s weak economies with the threat that the American economy soon slows too. There is also the possibility that the American economy reaccelerates, and the Fed is forced to raise rates yet again, thereby cooling the global economy even further. Most point to all these factors as reasons for oil prices having remained range bound in August.

For oil markets, a US-Iran deal has already happened.

US officials privately acknowledge they’ve relaxed enforcement of sanctions on Iranian oil sales. Tehran restored production to the highest level since the ban kicked in 5 years ago and is shipping it most to China.#OOTT pic.twitter.com/6hkpVu0rvX

— Alexander Stahel 🇺🇦🇮🇱 (@BurggrabenH) August 26, 2023

As I look back over the past several months, I notice that some prominent oil pundits have made very bullish claims that have failed to materialize. Coming into June, they blamed the debt ceiling crisis for prices remaining low. Then once the debt ceiling crisis was over, they forecasted that prices would work steadily higher, possibly hitting $100 by the third quarter. When that did not materialize, it was because higher interest rates caused destocking, meaning that higher interest rates made keeping inventory an expensive proposition. Then once OPEC+ made its announcement of curtailing production on a voluntary basis, that was a sure sign that prices would accelerate to the upside. As July and August have passed, many are still clinging to the idea that oil prices will still hit $100 by year end.

Stepping back from narratives from pundits, we can look to an options model to quantify the likelihood of WTI exceeding $100 in December or January.

Figure 1: Screenshot of thinkorswim’s Quotes for Oil Futures and Options

Figure 1 shows thinkorswim’s option Greeks for /CL, which is WTI, for options expiration in December, even though it says January, and for options expiration in January, even though it says February.

The January 2024 oil futures expire 114 days from today, Sunday, August 27, 2023, on Tuesday December 19, 2023. The last day for trading options on thinkorswim is 109 days on Thursday, December 14, 2023.

And the February 2024 oil futures expire 148 days from today on Monday, January 22, 2024. The last day for trading options on thinkorswim is 143 days on Wednesday, January 17, 2024.

The CME Group provides an oil futures calendar as to when the futures expire. The brokerage thinkorswim indicates when the last date for options trades are allowed on its platform. As we saw, the last options trading date precedes the futures expiry date by a few days.

Looking at the options that expire on December 14, 2023, we note that the call delta is 0.0671. Delta can be used as a rough proxy for the probability that the underlying future will close at or above the strike price. In other words, the probability that WTI closes at or above the strike price of $100 by option expiration is about 6.7 percent. The probability of touching the strike price between now and option expiration is roughly twice the delta value. In other words, between August 27 and December 14, there is 13.4 percent probability that oil prices at least touch the strike price of $100.

Following the same logic and process, the probability that WTI closes at or above the strike price of $100 by option expiration on January 17, 2024, is about 8.7 percent. And between August 27 and January 17, there is a 17.3 percent probability that oil prices at least touch the strike price of $100.

It is important to note that looking at the oil prices, we need to reference the correct future price. For example, when I took this screenshot, the commonly quoted WTI price was 80.21, which is the October future that expires in 24 days on Wednesday, September 20, 2023. The January and February futures prices, however, were $79.02 and $78.40 respectively.

From this information, the odds of WTI surpassing $100 by year end do not look overwhelming. If one believes that oil prices will easily exceed a $100 per barrel by year end, then the call options are seemingly inexpensive.

Also, please note that this information is dynamic. If oil prices spike in September to $90, those January and February options will be more valuable then than they are today.

Although I have never traded options on oil, I have traded a lot of options on equities. There have been several times when I have had an equity blow through options that were initially at a 10 percent probability. These prices and probabilities are a snapshot in time; they can change dramatically in a heartbeat.

So when you listen to pundits opining on extreme price movements, ask yourself if the options markets agree. If the options markets do not agree, then you can either reassess the pundits’ opinions, or if you believe a pundit, then take action in the futures or options markets.

Having said taking action, I would caution those who are considering using futures or options in commodities. These contracts are often large, in that a lot of capital is at risk, and if you are not careful, you can lose a lot of money fast. Many commodities have mini and micro contracts. Those contracts are likely a better place to start until your understanding and risk tolerance increases to match that for larger-sized contracts. Caution is also warranted for equity options. It is easy to wrap your account around the proverbial pole. Before investing in options, make sure that you have sufficient knowledge and start small.

Wrapping up, I forecast September WTI oil prices to range between $70 and $90 per barrel.

For August, I am raising my July forecast for West Texas Intermediate (WTI) oil by $5 per barrel to range between $70 and $90 per barrel.

The voluntary OPEC+ cuts by Saudi Arabia and Russia have tightened the physical markets and raised the price of oil. And, according to an article from Javias Blas of Bloomberg, “The Harsh Truth: We’re Using More Oil Than Ever” (subscription required), oil demand remains strong. A quote from his article is as follows:

So far, we have only partial numbers for May and June, and directional evidence for July. Extrapolating from earlier this year, the fresh information, including real-time traffic congestion in multiple countries and global airline travel, suggests that global oil demand went above the pre-Covid peak recently, even when considering the margin of error.

We do have much better information for the January-to-April period. Global oil demand averaged 100.8 million barrels a day during the first four months of 2023, above the same period in 2019, when the average was 99.9 million, according to my calculations based on monthly data from the IEA.

That said, according to the Patrick De Haan, the GasBuddyGuy on X, the peak gasoline demand for summer is likely behind us.

According to GasBuddy data, week-to-date gasoline demand is down 0.7% from last week and 1.8% below the four week moving average. It appears likely that demand for the summer may have peaked.

— Patrick De Haan ⛽️📊 (@GasBuddyGuy) July 29, 2023

OPEC+ is meeting in early August. I anticipate Saudi Arabia will continue its voluntary cut into September and otherwise do not expect any changes. If it decides to maintain its cut, that should help support oil during the shoulder season. The oil shoulder season is typically from after Labor Day until the end of October.

The S&P 500 has been strong over the past few weeks, surprising a lot of stock market pundits. If the market should correct after this run, then I would expect oil to correct along with the market.

Although North American markets have been strong, Europe is weaker. And China has surprised many, including me, by having had a weak year so far.

The New York Times published an informative podcast on China titled “China’s Economic Rebound Hits a Wall.” I encourage you to listen to it: Apple Podcasts; Google Podcasts; and Spotify.

The Financial Times published an article “Work dries up for US consultancies in China after national security raids” (subscription required), which complements the New York Times podcast.

Top US consultancies are struggling to attract business in China as Beijing’s national security raids scare away local clients and global investors pull back from dealmaking in the country.

Management consultancy Bain is telling new China hires to wait until as late as 2025 to start their jobs, while roughly half of McKinsey staff do not have paid client projects to work on. Boston Consulting Group’s China team has been holding strategy sessions on how to revive its flagging business, according to half a dozen people close to the firms.

Just after publishing my blog entry last month, I watched a YouTube video titled “The Chinese Yuan ‘Doom Loop’ & The Oil-Dollar Wrecking Ball with Michaeal Kao and Alexander Stahel.” Watching my Twitter, now X, feed, these two individuals have been negative to flat on oil prices for at least the last six months. I always found their commentary frustrating because it was counter to my more bullish outlook. The reality is that they were correct. So it is always good to pay attention to those who espouse a different viewpoint or outlook. Even though this past month their ursine outlook has not proven itself correct, you should find value in their thinking. And I would encourage you to follow them on X: Michaeal Kao and Alexander Stahel.

In summary, although there remain lots of crosscurrents that are affecting oil, I am expecting WTI prices to range between $70 and $90 per barrel for August.

For July, I am maintaining my June forecast for West Texas Intermediate (WTI) oil to range between $65 and $85 per barrel. As I write this blog entry on June 30, WTI is about $70.50 per barrel.

Once again, I had expected stronger prices. Some of the pundits that I follow expected that once the debt ceiling crisis was past, oil prices would rise. Some even stated that OPEC+ did not need to cut further at their early June meeting. Once the debt ceiling issue had passed and even though the Saudis announced a cut of a million barrels per day for July, oil prices still stagnated. One can only imagine prices if the Saudis had not cut.

The EIA revised its US demand for April upward based on monthly data. Below is a back-and-forth discussion between zerohedge and Javier Blas from Bloomberg.

The Biden admin will not stop fabricating data and draining the SPR to push the price of oil lower https://t.co/mxYq4hyCnY

— zerohedge (@zerohedge) June 30, 2023

They are not "fabricating data". We are all well aware of the problems with weekly estimates vs monthly data based on real survey. The problem is a long-standing one, and was present similarly with Republican and Democrat administrations.

— Javier Blas (@JavierBlas) June 30, 2023

When is the last time demand estimates were revised lower

— zerohedge (@zerohedge) June 30, 2023

In January 2023:

Weekly data: 19.674m b/d. Monthly data: 19.539m b/d

For a revision (lower) of -135,000 b/d | #OOTT

(So that's four months ago, as current data is April)

— Javier Blas (@JavierBlas) June 30, 2023

Javier Blas wrote an article on May 16, 2023, “The Oil Market’s Real Weakness Is Supply, Not Demand” (subscription may be required), where he stated the following:

Is the extra supply from Russia, Venezuela and Iran a sign that the Western sanctions aren’t working? No. It’s a sign the sanctions prioritize keeping the oil market well supplied, even if that means that Moscow, Tehran and Caracas can sell oil. Ignore Western politicians talking about using sanctions to cripple rogue petro-dictators; what they want is to cripple inflation. For now, the strategy has worked. It remains to be seen if it will survive the summer, when oil demand growth is likely to accelerate.

Strong supply from Russia and Iran, China’s tepid recovery, and likely higher interest rates all weigh on oil prices. The US no longer tapping the strategic petroleum reserve and the Saudis seemingly determined to strengthen the physical market should, at a minimum, keep oil prices steady.

A June 29 Bloomberg article “Brent Oil Set for Record Run of Quarterly Losses on High Supply” (subscription may be required) states the following:

The outlook for the second half is mixed. Some analysts have forecast that the market will tighten, in part due to the end of seasonal maintenance. Yet US Federal Reserve Chair Jerome Powell and some of his peers have said more interest-rate increases are likely, which would drag on energy consumption.

“We fear that market apathy and lack of risk deployment will compound further if the global physical market does not tighten,” Royal Bank of Canada analysts Michael Tran and Helima Croft wrote in a note. “This could end up being a lost year for the oil market as risk remains on the sidelines.”

In the video accompanying the above article, Amrita Sen of Energy Aspects worries that sovereigns, perhaps PEMEX of Mexico, may hedge its output. When sovereigns go to the market to hedge, that puts downward pressure on oil prices.

Regarding the recent developments in Russia, I am ignoring them because I do not believe they will affect oil prices.

My own bias is that prices should stabilize or move higher from here. My bullishness has been wrong so far this year. So I look forward to seeing how July unfolds.

I hope everyone enjoys a great start to their summer vacation.