Specious Argument

For May, I am increasing my April forecast by $5 per barrel for West Texas Intermediate (WTI) oil to range between $70 and $90 per barrel. On Friday, April 28, WTI was about $76.50 per barrel.

The last two months have been tumultuous. Two months ago was the start of another banking crisis, and one month ago, OPEC+ announced production cuts to start in May. Both of those events affected WTI’s price. After OPEC+ announced its cuts, oil rallied, though much of that rally has been lost since mid-April.

I lean bullish because many oil pundits expect a strong second half to 2023 and the driving season is rapidly approaching.

Paul Sankey, who is often seen on CNBC and who now runs his own research company, produced a YouTube video while visiting Calgary, Canada in mid-April. In his video, he also expressed a bullish outlook for oil.

The banking crisis has not completely resolved itself. In fact, according to the Financial Times article “JPMorgan, Citizens and PNC submit bids for First Republic” (subscription required), US regulators are racing to sell all or part of First Republic before the markets open on Monday, May 1.

At least three large banks have submitted bids to buy all or part of First Republic, the embattled California lender that US regulators have been racing to save this weekend.

Among those that have put in offers are JPMorgan Chase, PNC and Citizens, according to three sources with knowledge of the situation.

Along with the banking crisis, many continue to worry about the health of the global economy.

Because OPEC+ will start its cuts in May, its effects have not yet been felt in the physical markets.

On balance, I continue to lean bullish. While the banking crisis and general state of the global economy remain a concern, the global economy should remain strong enough to continue to demand more oil and the oil cuts will likely create a floor for prices, if not strengthen prices.

For April, I am reducing my March forecast for West Texas Intermediate oil (WTI) by $5 to range between $65 to $85 per barrel. As I write this blog post in the evening of March 30, WTI is hovering around $74.40 per barrel.

Last month I mentioned that as long as the general economy remains healthy, prices should strengthen. Of course, that did not take into account the March banking crisis that everyone is now well aware of. It seems when there is an adverse economic development, oil seems to immediately and disproportionately suffer, perhaps because traders remember all too well how oil suffered during the great financial crisis in 2008 and, again, during the initial COVID-19 breakout.

There were other factors, too, however. There was a negative gamma effect heading into options expiry. The negative gamma effect of financial institutions having sold protective puts on WTI oil prices to various producers. As WTI approached key strike prices, those financial institutions needed to sell oil futures to hedge themselves. A March 26, 2023, the Wall Street Journal article “How Options-Hedging Turbocharged Oil Volatility: Trade amplified a price drop to 15-month lows and now could help fuel a rebound” (subscription required) provides a more in-depth explanation.

Earlier this month, oil’s steepest weekly slide in almost three years accelerated as futures approached levels where many producers owned derivatives designed to lock in prices. As declines mounted, banks and trading firms on the other side of those trades had to unload crude to mitigate potential losses, investors said, dragging benchmark prices to 15-month lows.

Now, many expect similar dynamics could add momentum to any rebound if the economic outlook improves—leading to more expensive oil that could increase the cost of gasoline and diesel later this year. It is the latest example of how volatility in financial markets can spill into the real world, shaking an oil industry stretching from the shale basins of Texas to refineries in China.

The recent retreat “in many ways had not a lot to do with oil,” said Ben Luckock, co-head of oil trading at Trafigura Group, at an industry confab hosted by the Financial Times last week. “We got caught up in the macro world again, which happens all the time. It’s OK,” he added. “But it distorts what happens in the future.”

The article displays a graphic from Standard Chartered Commodities Research where it shows the producer put-option volumes skyrocketed from about 50 thousand barrels per day to nearly 300 thousand barrels per day at a strike price of $70. In other words, as WTI approached $70, financial institutions were forced to hedge their short put positions.

As an aside, the article further mentions that Mr. Andurand, who runs a $1.3 billion energy hedge fund, believes oil prices could hit $140 per barrel by the end of the year. He is likely referring to Brent prices, which tend to be $5 to $10 higher than WTI prices.

In addition, there were technical price levels that were breached, and the number of long oil futures was at recent lows. All these factors likely reinforced each other to help drive WTI prices down to the mid $60s before rebounding this week.

Often when oil prices suffer a significant fall, a passage of time is required before traders and investors regain their confidence to push oil prices back to prior levels. Furthermore, the banking crisis will cause some, if not most, banks to scale back their lending as they fortify their financial positions. This scaling back in lending practices will do some of the Fed’s work in slowing the economy, which is likely to be a drag on oil prices.

Regarding the economic effects of contracting credit, Ray Dalio wrote two interesting books regarding how the economic machine works: first, Principles for Dealing with the Changing World Order: Why Nations Succeed and Fail, and second, Principles for Navigating Big Debt Crises. Please note that I have used Amazon affiliate links for both books. Also, I encourage you to view his 31-minute video “How the Economic Machine Works.”

Because of the increased uncertainty caused by the banking crisis and the general skittishness of investors and traders, I have lowered my price range by $5 per barrel for April. In general, I am still bullish on oil and expect prices to strengthen in the second half of the year.

For March, I am extending my February forecast for Texas Intermediate (WTI) oil to continue to range between $70 to $90 per barrel. Oil closed near $75.50 on Monday, February 27, 2023. As we move from refinery maintenance season toward driving season, oil prices should begin to firm up.

When I wrote about a month ago, the S&P 500 Total Return Index, which includes dividends, was up about 6.1 percent year to date. As I write, it is up about 4.0 percent. Just like last month, I remain concerned that the stock market may still be too high. Some of last month’s bullish sentiment has dissipated. And if there is a market correction, then oil prices are likely to succumb to the gravitational pull of lower prices. More likely, however, oil prices during March will remain around $80 per barrel.

Looking at the CME FedWatch Tool, we see the market expects higher rates for longer. For example, the probability that the target rate meets or is greater than 525-550 basis points for the December 13, 2023, meeting exceeds 50 percent. Some argue that stock prices have not fully factored in these higher rates and lower margins. Because I remain cautious on the stock market, I also remain cautious on oil prices.

As driving season approaches, we may have more clarity on interest rates and the general economy, and as long as the economy remains healthy, oil prices should strengthen.

I am forecasting that West Texas Intermediate (WTI) oil will range between $70 to $90 per barrel during February. Oil closed near $80 on Friday, January 27, 2023.

As everyone is aware, China’s reopening continues. Josh Young on Twitter has been chronicling the rise in flights in China. As you can see from the picture from his thread below, flight count may have bottomed, and that may be indicative of China’s economy.

January 28th: 7 day trailing average of 10,858 China to China flights. The flight count may have bottomed and I'll be watching for a rebound as the Lunar New Year lull ends. An increase in international flights will be an important focus as well. pic.twitter.com/Q6t97rUTHV

— Josh Young 🦬🛢️ (@Josh_Young_1) January 28, 2023

Even though flight activity looks healthy, we should continue to monitor China’s reopening to confirm that it remains healthy.

Many, perhaps even most, expected global economies, especially European economies, to be much weaker than they appear today. On January 22, however, the Financial Times wrote about the change in sentiment in “Eurozone set to avoid recession this year as economists’ gloom lifts” (subscription required).

The eurozone will avoid a recession this year, according to a widely-watched survey of economists, which illustrates the sharp about-turn in global economic sentiment in the past couple of weeks.

As recently as last month, analysts surveyed by Consensus Economics were predicting the bloc would plunge into recession this year. But this month’s survey found that they now expect it to log growth of 0.1 per cent over the course of 2023. This is thanks to lower energy prices, bumper government support and the earlier-than-anticipated reopening of the Chinese economy, which is set to boost global demand.

The upgrade comes after officials and business leaders at this week’s annual World Economic Forum in Davos also embraced a more upbeat outlook, and the IMF signalled that it would soon upgrade its forecasts for global growth.

Early in the new year, however, oil tends to be somewhat soft. Northern countries are tapering their oil purchases for heating, refinery maintenance season is beginning, and the summer driving season has not yet begun.

The Fed does not appear to be a concern. According to the CME FedWatch Tool, there is a 98.4 percent probability that the Fed hikes by 25 basis points, or 0.25 percent, to a target range 450-475 bps.

The stock market has been stronger than I expected, with a 6.1 percent return as of last Friday. If there are any blips in the markets, oil may fall toward $70. When there is a strong risk-off period, oil tends to fall with other asset classes. Otherwise, I expect oil to hover around $80 or a bit higher.