Why Crude Oil Trades So Poorly

Crude oil is the new widow maker.  It trades heavier than a wet dawg in a New York thunderstorm.    Rallies have no legs and it seems the only bid these days are the shorts scrambling for cover.

ST_Crude Price.png

Note the recent lower highs and lower lows and stiff  resistance at the 50 and 200-day moving averages.

Technology Rapidly Changing Oil Industry

Maybe it because of the huge technological progress, which, has, for example,  driven the cost of the breakeven for some deep water drilling projects down 50 percent in the past few years.   Deep water projects, some of which, used to cost north of $100 per bbl elsewhere throughout the world have fallen to around $40–$50 per barrel in the Gulf of Mexico.   Absoulutely stunning!

OPEC is fighting the same forces that did “John Henry, the steel driving man” in.  And, for that matter, the same changes that have wiped out most of the floor traders on the NYSE.  Technology.

We came across this Foreign Affairs piece yesterday that absolutely floored us (be sure to click Foreign Affairs to read full article),

 The technology revolution has transformed one industry after another, from retail to manufacturing to transportation. Its most far-reaching effects, however, may be playing out in the unlikeliest of places: the traditional industries of oil, gas, and electricity.

…These technologies have helped drive oil prices down from an all-time high of $145 per barrel in July 2008 to less than a third of that today, and supply has become much more responsive to market conditions, undercutting the ability of OPEC, a group of the world’s major oil-exporting nations, to influence global oil prices.

…. As the price of oil tumbled from above $100 per barrel in early 2014 to below $50 per barrel in January 2015, many of these projects [deep water] stalled. By early 2016, companies had put on hold an estimated four million barrels per day of new oil output, 40 percent of it from deep-water sources.

…As drilling stalled, oil and gas operators, desperate to cut costs, began to rethink the complex systems they used.

Today, thanks to these innovations, the average breakeven prices of new deep-water projects have fallen, to just $40–$50 per barrel in the Gulf of Mexico—an important global bellwether because it is one of the most responsive regions in the world to changes in market conditions. Even though oil prices remain low (and many in the industry expect them to stay low), investment is once again growing. Ten deep-water projects were approved for investment in 2016 and the first half of 2017 alone.  – Foreign Affairs

Technology only moves forward unless the Luddites take power, which given recent events can’t be entirely dismissed.   So, our guess is the long-term pressure on crude prices is lower.

The Middle East Mess

Shorter term,  however, we wouldn’t be surprised to see a “wag the dog” event in the Middle East and a price spike as there is currently no geopolitical risk premium in the crude price.  The Saudi-Iran conflict continues to heat up as they fight their  proxy wars across the region from Yemen to Syria.

Just yesterday, for example,  Iran took four Saudi sailors into custody and seized their naval vessel  after they entered Iran’s territorial waters in the Persian Gulf.     One stray missile into the side of an oil tanker in the Straights of Hormuz could send prices up $20 per bbl..  Certain emasculation of the leveraged shorts.   Suppliers would jump on those prices faster than a portfolio manager chasing a 7 percent yield on a 100-year Argentina bond, however.

Being short crude here is therefore not a sleep easy trade.   But, when is it ever an easy trade?

Conclusion

If the above is true, and we could be entirely wrong as articles such as these are not uncommon at bottoms,  the world and geopolitical forces that drive it are in for huge upheaval.

Breakeven_Crude Prices

Not only has the supply curve shifted way right it has become flatter or more elastic, that is sensitive to price moves.   The same is true for demand, which has shifted left in the west though it has increased in the emerging markets.   We wouldn’t bet on a huge spike in longer-term demand as technology — as in electric cars (hint Volvo) – continues to evolve at a rapid pace.    “In 2016, approximately 45 percent of the global oil demand was attributable to the road transportation sector.”

Oil Demand

 

Crude Prices_July8

Crude_Oil_July8.

Real Crude Prices

Finally,  it is important not to conflate crude oil’s relative price decline with a generalized global deflation.  It’s kind of frustrating to observe policy makers and market watchers exclude energy prices from the inflation indices when prices are rising and include them when prices are falling.  Easy money bias.

Maybe it’s time to sell those buggy whips.

Stay tuned, folks.

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17 Responses to Why Crude Oil Trades So Poorly

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  7. Erik says:

    200DMA drawn on a single-month contract chart are meaningless, counter-productive, and misleading. And frankly their very inclusion in an article brings rise to serious questions about the competence of the author(s). If you want to see the 50 and 200DMA, you need to draw them on a nearest-futures chart, where you would see a completely different picture. Read Schwager on Futures if the basics of technical analysis of futures markets really confuse you so much!

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  14. Michael J Moran says:

    I doubt the $50 a barrel number on offshore. Even if correct currently (which I doubt), it is only because offshore drilling companies have to discount rigs. So a low price of oil always reduces the drilling cost because of slack n service sector. Likewise a high cost of oil increase drilling cost for same reason. Gulf of Mexico is also generally a low cost offshore play, not like North Sea or other deeper or harsh weather places.
    Look at oil price crash of 90s. Crash started in 96, oil hit $10 a barrel in 98 (and at that time had famous Economist cover saying oil was going lower) and it took till 2004 before price took off. Current crash started in 2014, had $26 oil in 2016, maybe in 2020 or 2022 oil takes off.

  15. Peter Jarvis says:

    Technological change is clearly part of this issue – and it’s called multi-pulsating fracking. This is changing costs (lower) and dramatically increasing supply (almost exponentially) and will for many year. This is most true in the old US of A which will soon be the biggest producer and and one of the most important exporters of petroleum products in the world!

  16. Pingback: 07/11/17 – Tuesday’s Interest-ing Reads | Compound Interest-ing!

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