**NEW Quarterly Overview**
Ethanol declined, coal for delivery in Rotterdam edged lower, and gasoline crack spreads fell since January 5. Brent and WTI crude oil futures, gasoline, heating oil, distillate crack spreads, and natural gas posted impressive gains since January 5.
February NYMEX crude oil futures moved 6.15% higher since January 5 to settle at $82.64 per barrel, after making a new continuous contract high at $85.41 on October 25 and a low of $62.43 on December 2. NYMEX crude oil had been making higher lows and higher highs since April 2020. The selloff did not negate that pattern as the price remains above $61.74, which is critical technical support. The price action since the December 2 low remained bullish.
As I have been writing for months:
“OPEC and Russia are the prime beneficiaries of changes in the US regulatory environment. OPEC’s mission is to optimize returns for petroleum producers, which is bullish for the global petroleum markets. As I had been warning, the pricing power in the crude oil market has passed from the US to the oil ministers and Russia as the shift in US energy policy means less output from the country that was the world’s leading producer. The changes in global petroleum dynamics are a significant event with ramifications for the coming years. Rising tensions between President Biden and the Russians and Saudis only add to OPEC+’s desire to extract as much as possible from US consumers. The potential for much higher prices remains a clear and present danger. The administration’s request for OPEC+ to increase output would be comical if it weren’t tragic. At the latest OPEC+ meeting on September 1, the cartel officially denied the request, leaving production policy unchanged from the last meeting. The oil-producing nations basically spit in the US administration’s face in another policy disaster following on the heels of the Afghanistan debacle. An inflationary environment increases the potential for higher oil prices. The administration ended oil and gas leases on federal lands in Alaska, which is not bearish for the prices of the traditional energy commodities. The move below $65 threatened crude oil’s bullish trend since April 2020.”
Crude oil powered higher in October, reaching the highest price since 2014 before correcting and probing below the $80 level in early November and falling below the $70 level on November 26. However, the August $61.74 low held, and the energy commodity turned higher. Technical support on February futures sits at $74.27, the January 3 low, with resistance at $85.41, the continuous contract high from late October. Crude oil eclipsed the $80 per barrel level over the past week.
March Brent futures underperformed the NYMEX WTI futures as they rose 4.75% since January 5. The critical technical resistance levels in March Brent are at $85.50, and $86.74, the 2018 high. Brent for January delivery was trading at the $84.68 level on Wednesday. Support is at $80.50, the January 10 low.
February gasoline rose 4.31% to the $2.3908 per gallon level after reaching $2.4026 on October 21 and a low of $1.8646 on December 2. The gasoline processing spread in February fell by 4.59% since the previous report. The active month February gasoline crack spread was at $17.67 per barrel after the continuous contract traded to a high of $27.76 on August 9. Gasoline crack spreads tend to exhibit strength during the summer driving season in the US and weakness during the fall and winter months. The futures market is now in the offseason for gasoline demand during the winter months.
February heating oil futures moved 6.06% higher since the last report. The active month February heating oil crack spread was 5.66% above the January 5 level. Heating oil is a proxy for other distillates such as jet and diesel fuels. Economic growth and increasing air travel demand boosted distillate prices over the past months. The February distillate crack spread closed on Wednesday at $26.32 per barrel after the continuous contract reached a new high at $27.15 on January 12. Distillates received support from increased demand for air travel over the past months. The crack spreads are a real-time indicator of demand for crude oil as well as barometers for the earnings of refining companies that process raw crude oil into oil products.
I pointed out that:
“The crack spreads could be a significant indicator of demand over the coming weeks and months.”
A cold spell over the coming weeks and months could ignite the energy commodities and push prices to higher highs in the US. Crude oil suffered from fears that a new COVID-19 variant will curtail travel and energy demand.
The measure of daily historical volatility in NYMEX crude oil was at 27.0% on January 12, higher over the past week. The price variance metric in February futures rose to its highest level in 2021 at just over 82.30% on December 7. Since crude oil tends to take the stairs higher and an elevator lower, volatility tends to move lower during bullish periods and vice versa. Daily historical volatility spiked higher on November 26 from the 27.24% level on November 24 to 82.32% on the high.
US energy policy is the most significant factor in the oil market in 2021. Daily production reached an all-time peak of 13.1 mbpd in March 2020. A more restrictive regulatory environment is likely to make that peak unattainable over the coming months and years. If the current variant does not pose a significant risk, the demand for crude oil is likely to continue to rise. OPEC and Russia are in a more influential position when it comes to supplies. Worsening US-Saudi relations that push the KSA towards Russia could exacerbate the rift and drive oil prices higher.
Crude oil posted gains over the past seven consecutive quarters. The close over $75.12 on December 31 extended the streak to seven quarters.
Meanwhile, the Middle East remains a potential flashpoint for the crude oil market. The area is home to more than half the world’s crude oil reserves. Any hostilities that cause supply concerns could send the price of crude oil for nearby delivery appreciably higher in the blink of an eye. The Middle East could provide surprises to the oil market, but global demand remains the primary factor for the price over the coming weeks. Iran remains a turbulent factor in the area that is home to over half the world’s crude oil reserves. Even though the Biden administration seeks to move back into the nuclear nonproliferation treaty with Iran, tensions between the two nations remain high. The dramatic shift in US production policy increases OPEC and Russia’s influence in the crude oil market, which is ultimately bullish for the price of the energy commodity. The situation in Afghanistan weakened the US’s negotiating position in the Middle East and could open the possibility of hostile acts from enemies.
Crude oil open interest moved 4.21% higher over the past week. NYMEX crude oil rose 6.15% since the previous report. The energy shares outperformed crude oil since December 22. The XLE moved 7.03% higher since the previous report. When it comes to the energy-related shares, we should continue to see consolidation in the oil business over the coming months.
In previous reports, I wrote:
“I would only consider those with the most robust balance sheets like XOM and CVX in the US. Exxon and Chevron could stand to pick up lots of production assets at bargain-basement prices over the coming months as the number of bankruptcies rises in the oil and gas sectors. Both companies pay substantial dividends and have yet to cut or eliminate payments to shareholders. XOM and CVX are the two leading US integrated oil companies. I would only purchase these companies during corrective periods using wide scales.”
After buying the leading companies on weakness, I had taken profits on a scale-up basis. I added to long position positions over the past months during periods of price weakness but did no buying over the past week.
The spread between Brent and WTI crude oil futures in March moved lower the $2.66 per barrel level with a premium for Brent on January 12, down 71.0 cents since the previous report. The Brent premium tends to move higher during bullish periods in the oil market and vice versa. However, in the first months of 2020, it was the carnage in the price of WTI futures that drove the spread to higher levels. Brent crude can travel by ocean vessel to consumers around the globe, while WTI is a landlocked crude oil. The lack of storage capacity was responsible for the price action in the spread and outright prices in late April 2020 that took nearby NYMEX futures into negative territory. Meanwhile, any problems with Iran could cause the Brent premium to spike higher. The US failure in Afghanistan could have an impact in the Middle East, which would cause increased volatility in the oil futures arena.
A decline in US production could cause significant volatility in the Brent-WTI spread. Before 2010, WTI often traded at a $2 to $4 premium to Brent. The WTI grade has a lower sulfur content making it the preferable crude oil for processing into gasoline, the world’s most ubiquitous fuel. If US output continues to decline significantly and demand returns to the market, we could see it impact the Brent-WTI differential and cause periods where WTI returns to a premium to the Brent, which is better suited for refining into distillate products. The spread also reflects the political risk in the Middle East as the region uses the Brent price for its output. The USO and BNO ETF products replicate the short-term price action in WTI and Brent futures, respectively.
While both do an adequate job tracking the futures in the short-term, neither are particularly effective for medium or long-term positions because of the volatility of the forward curves in both crude oil benchmarks. The path of least resistance of the oil market will be a function of the ups and downs of the global pandemic and the stock market over the coming months. Iran and the pandemic continue to be factors that could prompt price volatility.
Term structure in the oil market experienced a significant shift as the price of crude oil tanked in March and April 2020. The flip from backwardation to contango in the spread reflected the flood of supplies in the crude oil market. Oil traders filled tanks and storage all over the world to take advantage of the wide contango with financing rates at historic lows. Cash and carry trades in the oil market became one of the only profitable areas of the market as demand evaporated back in February through April.
The cash and carry trade put upward pressure on freight and storage rates. The forward curve had moved to the widest contango in years. The contango caused the price of May futures to plunge to an incredible low of negative $40.32 per barrel. As prices moved higher since late April 2020, the contango declined and moved into backwardation.
Since January 5, crude oil for delivery in March 2023, minus March 2022, moved from a backwardation of $6.73 to a backwardation of $9.36 over the period, tightening by $2.63 per barrel over the period, which is a short-term bullish factor. The backwardation traded at a new $10.12 high on October 20 and is approaching a test of that level. In 2021and early 2022, the March-March one-year spread had been in backwardation in a range from a $0.97 to $10.12 premium for the nearby contracts.
The backwardation widened over the past weeks as crude oil prices moved higher. Rising contango is a sign of a glut in the oil market, while falling contango and backwardation signifies tighter supplies. Falling production causes the spread to tighten. Any problems in the Middle East could cause lots of volatility in the term structure for crude oil as they would likely push nearby prices higher compared to deferred levels. Over the past week, the backwardation in the March-March spread widened as the term structure in WTI tightened. The number of rigs operating in the US was up one over the past week.
According to Baker Hughes, on December 31, the number of rigs in operation was at 481, 206 above the level at the end of 2020. US energy policy will cause drilling activities to decline, the number of rigs operating dropped precipitously last year as the pandemic caused industrial activity, mining, and drilling to grind to a halt. Higher prices caused rig counts to rise in the US, but not at the same rate they would given the regulatory environment under the Biden administration.
US daily production stood at 11.70 million barrels per day of output as of January 7, according to the Energy Information Administration, down 100,000 bpd since the previous week. As of December 31, the API reported a decline of 6.432 million barrels of crude oil stockpiles, while the EIA said they decreased by 2.10 million barrels for the same week. The API reported a rise of 7.061 million barrels of gasoline stocks and said distillate inventories increased by 4.34 million barrels as of December 31. The EIA reported that gasoline stocks rose by 10.10 million barrels and said distillate stockpiles moved 4.40 million barrels lower from the previous week. The inventory data was bearish for the crude oil market as products increased far more than crude oil stocks declined. As of January 7, US production dropped by 1.40 million barrels per day or 10.69% since the March 2020 record high in output. The shift in US energy policy does not support oil companies to make the investments that would increase output.
OIH and VLO shares moved higher since January 7. OIH rallied 8.16%, while VLO moved 7.89% higher over the period. OIH was trading at $219.56 per share level on Wednesday. I am holding a small position in OIH. We are long three units of VLO at an average of $63.81 per share. VLO was trading at $84.37 per share on Wednesday. The shares should follow the crude oil and stock market over the coming days and weeks. I remain cautiously bullish on OIH and VLO and added to long positions in late November and early December.
February NYMEX natural gas reached a new high at $6.557 per MMBtu on October 6 and then tanked to $3.518 per MMBtu on December 23. The high was the highest price since 2008 as it was above the February 2014 $6.493 high. Shortages in Europe and Asia put pressure on US LNG exports, which had been bullish for US natural gas prices. Warm forecasts pushed the price below the $4 level before the weather turned cold and the price exploded over the past week. February natural gas was at the $4.857 level on January 12 as the winter months are in full swing. February natural gas futures moved 25.44% higher since January 5 as extreme volatility returned to the natural gas arena.
Support in volatile February natural gas futures is at $4.077 per MMBtu, the December 29 high and breakout level. Technical resistance is at $5.40, $5.562, and $6.466 on the continuous contract, the October 6 high. Natural gas had been a wild market over the past months, but the price action calmed over the past weeks as the energy commodity made lower highs and lower lows since the early October peak. The calm turned into a bullish storm over the recent trading sessions.
The EIA said stocks fell by a less than expected 31 bcf to 3.195 tcf for the week ending on December 31. Stocks were 4.6% below last year but 3.1% above the five-year average during the heart of the withdrawal season. The EIA will report inventory data for the week ending on January 7 on Thursday, January 13. The market expects a far bigger 131 bcf withdrawal from storage.
Stockpiles peaked at 3.644 tcf at the start of this winter, 314 bcf below last year’s 3.958 tcf peak. Baker Hughes reported that a total of 107 natural gas rigs were operating in the US as of December 31, up one from last week and 23 above last year’s level. LNG shipments to destinations outside the US are an expanding demand vertical for the natural gas market, pushing the number of operating rigs higher. However, US energy policy that increases regulations on fracking could weigh on further increases and supplies and support the price of the energy commodity. Natural gas will move with the weather reports over the coming weeks. A cold period could propel prices higher.
Open interest moved 1.71% higher in natural gas over the past week. Price momentum and relative strength on the daily chart were at overbought readings and rising on Wednesday.
As I wrote in previous reports:
“I continue to expect the natural gas market to reflect the shift away from fossil fuel production under the Biden administration. Lower production and increased global demand are leading to higher base prices for the energy commodity. The shift in US energy policy is clearly bullish for oil and gas. The risk of a correction increased with the volatile price. Day trading natural gas offers many opportunities, but make sure you approach the market with a risk-reward plan and stick to it no matter what. Natural gas has destroyed more stubborn market participants than almost all other markets. Do not be one of the statistics. Risk-reward is critical in the natural gas arena, where volatility is best suited for trading instead of investing. The recent price action has been head-spinning.”
Natural gas was back in hyper-bullish mode on Wednesday.
February Chicago-swap ethanol prices were 4.74% lower since January 5, with the price at $2.1100 per gallon wholesale. The price of February thermal coal futures for delivery in Rotterdam edged 1.53% lower since last week. The demand for metallurgical coal for steel making had been robust over the past months, but the energy commodity ran out of steam as China stopped buying and started selling. Thermal coal for delivery in Rotterdam traded at the highest level since July 2008 in October. The record peak in nearby coal futures was at $224 in July 2008. In October, coal hit a new record high at $286.05 per ton. Gravity hit the coal market over the past months. The February futures price moved lower from $131.00 on January 5 to $129.00 per ton on January 12.
On Tuesday, January 11, the API reported that crude oil inventories fell by 1.077 million barrels for the week ending on January 7. The API said gasoline stockpiles rose by 10.860 million barrels, and distillates increased by 3.035 million barrels for the week. On January 12, the EIA reported that crude oil inventories moved 4.60 million barrels lower for the week ending on January 7. The EIA said gasoline stocks rose by 8.00 million barrels, and distillate stockpiles moved 2.50 million barrels higher. The API and EIA reports were bearish for the price of the energy commodity but that did not stop the price from rallying.
Weather, US energy policy, geopolitical events, the stock market, and the US dollar will guide the price action in the crude oil market over the coming weeks and months. Natural gas is in the withdrawal season. While natural gas typically displays strength during the injection season, weather forecasts weighed on the energy commodity after changes in US energy policy supported the price during the seasonally weak injection season. We are now in the peak demand season in the natural gas futures arena. US relations with Iran and Saudi Arabia could add to price volatility in the oil market over the coming months and years. OPEC+’s stance on production is likely to be a week-to-week affair.
I have been taking profits quickly and stopping losses looking for a 1:2 risk-reward ratio on forays into the crude oil futures market. UCO and SCO products can be helpful for those who do not trade futures. In natural gas, I have been using the BOIL and KOLD products, which offer some leverage on the long and short sides.
We are holding a long position in PBR, Petroleo Brasileiro SA. At $12.02 per share, PBR moved 12.02% higher since January 5. I have a small position that I will hold as a long-term investment.
As I wrote when the shares dropped below the $8 level:
“I believe PBR is at a level that offers compelling value at below $8 per share.”
Tight stops continue to be the key when approaching energy commodities in the futures or ETF arena. I am only bought the top companies and ETFs, including XLE, CVX, XOM, OIH, VLO, TOT, BP, RDS-B, and PBR. As of January 12, my position remained around 78% the level as when we moved towards the early July high, and I took some profits. I did some buying from November 26 through December 2 to increase the overall exposure.
Energy powers the world, and demand is critical throughout the rest of 2020. A sudden drop in the US stock market would likely weigh on crude oil prices.
I am trading natural gas from both sides of the market with very tight stops. I have only been trading in the crude oil and natural gas markets with very tight stops on futures and ETF products. I have been a buyer of leading oil companies. Keep an eye on events surrounding Iran as they could cause sudden price spikes. When taking risk positions home overnight or over weekends, keep the potential for Iranian provocations in mind. The theocracy in Teheran may want to further test the US as they look for an edge in nuclear talks and sense weakness because of the events in Afghanistan in late August.
In the past report, I wrote:
“Expect the unexpected in the energy sector. Crude oil will be watching the developments surrounding COVID-19 variants and the Chinese economy, along with the many other issues impacting the US and global economies.”
COVID was the excuse for the recent declines, while fundamentals continue to support higher oil prices. Natural gas remained in bearish mode as of January 5 while the other energy commodities shifted to short-term bullish trends.
While alternative fuels are the future, hydrocarbons remain the present. Consumers will pay higher prices as the cartel now has control. We are in a seasonally weak time of the year in gasoline, but US energy policy remains the most bullish factor for oil, natural gas, and coal, as the fundamental equation continues to favor higher prices. The risk of a correction rose with the oil price.
Be cautious. Protect capital on profitable positions in the energy sector. Corrections in the sector can be brutal, as we witnessed in natural gas falling by over 40% from the high to the recent low on the January contract and crude oil plunging over 25%. Approach all energy markets with a risk-reward plan.
Expect price volatility to continue over the coming weeks.
In the previous report, I wrote:
“I believe crude oil will find a low at a higher bottom. The $60 level on nearby NYMEX futures is a critical level to watch and monitor. Expect head spinning price action in the natural gas futures arena and in crude oil over the coming sessions. Be careful, do not let short-term trades turn into long-term investments. Take losses when you are wrong on trades. I am building long positions in oil stocks but am leaving lots of room to add if the correction deepens.”
In December, I recommended a long position on APA Corporation (APA), an oil and gas exploration and production company. We bought the shares at the $25.10 level on December 16. Since January 5, APA moved 14.97% higher to $32.65 per share on Wednesday.
Energy commodities experienced extremely bullish price action in 2021. US energy policy could keep the rallies going in 2022. Energy has been the best performing sector of the stock market so far in 2022.
A Final Note
The Fed minutes have weighed on stocks, bonds, and interest-sensitive commodities over the past week as precious metals declined. Meanwhile, inflation remains a clear and present danger that should keep the bullish relay race intact over the coming weeks and months. The December CPI data told us that the Fed is far behind the inflationary curve. The Fed’s target is an average of 2%. Core inflation rose by 5.5% in 2021.
I remain bullish on commodity prices, and that includes precious metals. I would not be shocked to see a sudden rally in the precious metals, which is long overdue given the underlying bullish inflationary trend.
I plan to increase the price of the report in the coming months. However, all of my current loyal subscribers will never experience an increase in their monthly or annual subscription rates. I will grandfather all subscribers at their current rates for as long as they maintain their subscriptions. Thank you for your support.
Until next week,
Any investment involves substantial risks, including, but not limited to, pricing volatility, inadequate liquidity, and the potential complete loss of principal. This document does not in any way constitute an offer or solicitation of an offer to buy or sell any investment, security, or commodity discussed herein, or any security in any jurisdiction in which such an offer would be unlawful under the securities laws of such jurisdiction.