Specious Argument

My forecast last month was too optimistic. I am lowering my prior forecast for West Texas Intermediate (WTI) oil price to range between $70 to $90 per barrel for December. This is a drop of $10 per barrel from last month. My typical monthly range is $20 wide. Although that range seems wide, sometimes it is not wide enough. If I were asked to narrow the range, I would provide a range of $70 to $80 per barrel. Because the oil prices did not jump after the announcement by OPEC+, I am less optimistic about much higher prices in December.

Earlier in the day, the Wall Street Journal featured an article “OPEC+ Agrees to Significant Oil-Production Cut” (subscription required).

OPEC+ agreed to a significant production cut of an additional million barrels a day, delegates said, in a move that will likely keep prices elevated amid the continuing conflict in the Middle East.

As part of the deal reached Thursday, Saudi Arabia also agreed to extend its cut of 1 million barrels a day that it announced in June.

Taken together, the moves are expected to stabilize prices at a moment when geopolitical tensions are high around the world and economic growth is slowing.

As I look back over the past year, I, along with many others, have been too optimistic. In early 2023, many thought that once the market got past the refinery maintenance season, prices would firm. That did not happen.

Then, as we approached the debt ceiling in June, many thought that once the debt ceiling issue was resolved, prices would go much higher. In fact, many were certain that oil prices in the second half of the year were going to go much higher. After the debt ceiling issue was resolved, oil prices continued to languish. The excuse then was that there was a lot of destocking because of higher interest rates.

Saudi Arabia and Russia cut production in the summer. Surely, that was a strong signal that any excesses in the market would be addressed, and oil prices were bound to go much higher. Oil prices did rise substantially into September and then drifted lower. In September, many thought oil prices would soon hit a $100 and stay at about that level or higher regardless of any macroeconomic concerns.

Now in late November, WTI prices are hovering around the mid $70s. There is no longer any talk of oil prices hitting $100 per barrel this year.

After OPEC+ made its announcement, oil prices fell. The oil market appears to be waiting to see proof that the voluntary cuts are made and that those cuts are having their intended effects upon inventory levels before boosting oil prices.

I am going to close this post with comments on X by Eric Nuttall, whom I greatly respect. If you click through to his comments on X, you will find a video link to his appearance on BNN Bloomberg.

"We remain bullish"…just not by as much as we were earlier this year. Why? We were right on 2 calls: global oil inventories reaching multi-year lows + demand vastly exceeding the ongoing bearish narrative (recession=demand destruction). What did we get wrong? The quantum of… pic.twitter.com/TZ5SqHwJ6e

— Eric Nuttall (@ericnuttall) November 30, 2023

I am keeping with my prior forecast for West Texas Intermediate (WTI) oil price to range between $80 to $100 per barrel for November.

When I provided an update last month, the price of WTI was hovering in the low-to-mid-$90s per barrel. As indicated in last month’s update, some pundits were calling for $100 Brent, which is about four dollars greater than WTI prices, by Halloween because crude fundamentals were strong enough to withstand macro headwinds. Since that time, however, macro headwinds have reduced oil prices.

During the past week, WTI prices were hovering in the low-to-mid-$80s even though, paradoxically, some pundits argue that the recent Israel-Hamas war has added a war premium of three-to-seven dollars per barrel. Yet some argue that the war has taken risk out of the market.

Please see Amrita Sen’s interview on Bloomberg Market Surveillance on October 30, starting with the lead-in at about 2:20:35 of the video.

So it appears that crude fundaments are not immune from macro headwinds. That said, I expect the WTI price of $80 per barrel to hold. With shoulder season just ending, refineries will demand more oil in the next two-to-three weeks. And some believe that oil prices are still headed higher. In its October 24 article “Andurand Says Oil Must Hit $110 Before Saudi Arabia Eases Supply Curbs,” Bloomberg quoted a well-known oil trader:

Oil trader Pierre Andurand said he expects Saudi Arabia to keep its current supply curbs in place until prices reach at least $110 a barrel.

As inventories decline in the coming months, “the market will have to beg for more supply at some point,” the founder of Andurand Capital Management LLP said during a question-and-answer session at Saudi Arabia’s Future Investment Initiative in Riyadh.

“The Saudis will have to decide when and at what price to bring supply back,” he added. “For me, an adjustment likely will come around $110 a barrel. So there’s room to the upside for prices.”

Of course, if the Israel-Hamas war were to spread and intensify, then oil prices could easily exceed the top of my range. There are many active efforts, however, attempting to keep this dangerous situation from becoming even more dangerous.

I hope in November that equity and oil markets stabilize and that the end of the Israel-Hamas war is within sight.

To summarize: my WTI oil price forecast for November is $80 to $100 per barrel.

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.