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Oil Update—March 2023

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.


Oil Update—February 2023

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.


Oil Update—January 2023

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.

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.


Oil Update—December 2022

For January 2023, I am forecasting that West Texas Intermediate (WTI) will range between $70 to $90 per barrel. Oil closed near $80 on Friday, December 30, 2022.

Pierre Andurand, a famous hedge fund manager who specializes in energy derivates, posted a bullish six-part thread on Twitter beginning with the following tweet:

He then followed up with another shorter three-part thread starting here:

Using these initial tweets, I encourage you to read his two threads.

While Andurand is relatively sanguine on COVID developments in China, others are less certain or even pessimistic.

On December 29, the New York Times featured an article “How Bad Is China’s Covid Outbreak? It’s a Scientific Guessing Game” (subscription required)

But in early December, the government abruptly abandoned “zero Covid,” leaving the scientific community largely in the dark.

“Nobody, nobody has a clue,” said Siddharth Sridhar, a clinical virologist with a focus on emerging infectious diseases.

Predicting the path of the pandemic has always been difficult. Even in places like Britain with reliable data, forecasts have often been far off the mark. But scientists have generally used reported Covid deaths as a dependable barometer to determine the potential size of an outbreak.

The best I can do is to monitor the situation and react accordingly.

I chose the range $70 to $90 because at $70, the US may begin to refill its strategic petroleum reserve and many may be fearful that OPEC+ will take corrective action to tighten the oil markets, and because oil demand does not appear strong enough in the first few months of 2023 to push oil prices much higher than current levels.

As we enter 2023, I will be watching closely developments in China, the Fed and the global economy, how Russia reacts to the cap on its oil prices, and how OPEC+ responds to either surpluses or shortages of oil.

I want to wish everyone a happy, healthy, and prosperous New Year!


Oil Update—November 2022

Although I am tempted not to provide a forecast range for December because of the high uncertainties, I will forecast a range of $75 to $95 per barrel for West Texas Intermediate oil.

Regarding COVID, I had expected more progress in China. Instead, COVID cases are increasing, and this past weekend, there were a number of demonstrations in China regarding COVID lockdowns.

The above chart by CN Wire on Twitter shows how the number of COVID cases in China has grown during the month of November. The Wall Street Journal article “Chinese Protests Spread Over Government’s Covid Restrictions” (subscription required) provides a video and discussion of events unfolding in China. Below is an opening excerpt:

BEIJING—Protests are erupting in major cities in China over President Xi Jinping‘s zero-tolerance approach to Covid-19, an unusual show of defiance in the country as the economic and social costs from snap lockdowns and other strict restrictions escalate.

Demonstrations occurred throughout the weekend in both Beijing and Shanghai. According to eyewitness accounts, there were also protests in the eastern city of Nanjing and in Wuhan, the original epicenter of the pandemic. Video footage and photos circulating on social media, which The Wall Street Journal wasn’t able to independently verify, suggest protests broke out in several other cities, including Chengdu, capital of Sichuan province.

The protests followed demonstrations on Friday in Urumqi, capital of the remote region of Xinjiang, where a deadly fire enraged residents who had struggled with lockdowns of more than 100 days. Residents flooded social media with comments suggesting that Covid restrictions contributed to a delay in putting out the fire, in which officials said 10 people died.

In addition to China’s COVID concerns, OPEC+ is set to decide its next production limits and Europeans are grappling with the price cap for Russian oil. In another article from the Wall Street Journal “Oil Prices Face Fresh Volatility With New Russia Sanctions, OPEC Decision” (subscription required), it states that oil has been volatile during the past month.

Brent-crude futures have risen or fallen by at least 1% on all but three trading days in November while sliding 12% over the course of the month to $83.63 a barrel. The oil benchmark traded in a range of more than $5.50 a barrel on one day last week after The Wall Street Journal said that the Organization of the Petroleum Exporting Countries and its partners had discussed an increase in output—a report denied by Saudi Arabia.

The European Union is expected to ban most crude imports from Russia on Dec. 5. In tandem, the U.S., the EU and some of their allies are due to ban shipping, trading, insuring and funding Russian crude anywhere in the world unless the price is at or below a cap.

From Feb. 5, the same sanctions will hit Russian refined products, a move that traders say poses a bigger threat to Moscow’s oil industry and a greater challenge for Europe.

From Feb. 5, the same sanctions will hit Russian refined products, a move that traders say poses a bigger threat to Moscow’s oil industry and a greater challenge for Europe.

OPEC+ is set to choose its next production quotas with an impending European oil price cap, increasing COVID numbers in China, and slowing global economies as the Fed and other central bankers continue to raise rates.

A November 21 Wall Street Journal article “OPEC+ Eyes Output Increase Ahead of Restrictions on Russian Oil” (subscription required) caused oil prices to immediately fall about $5 per barrel. Saudi Arabia denied the reports in the article, and oil prices immediately recovered. So I doubt Saudi Arabia will now increase production because of the severe market reaction.

Depending on the oil price chosen for the Russian oil price cap, it may be completely meaningless. And some believe that, regardless of what price is chosen, the price cap will be completely ineffective. I do not have an opinion but will wait to see what develops instead.

Obviously with all the uncertainty, it is hard to have any confidence in any forecast. My range is premised on OPEC+ taking into consideration all these uncertainties and wanting to minimize volatility. In other words, I expect OPEC+ wants to attempt to keep Brent prices at or near $90 per barrel. WTI prices are about $7 per barrel less than Brent prices.

December promises to be an interesting month.