Crude Oil Special: With “Blood in the Streets” is it finally time to go Long Crude Oil?
“The time to buy is when there’s blood in the streets…”
In August of this year, near month crude oil prices hit 37.75 per barrel, the lowest level since the 2008 financial crisis. By now, even if you’re not a commodities investor, you’re likely familiar with the reasons why: The emergence of the US as an oil superpower. The excess pumping of OPEC, the concerns over the global economy.
But are those factors still valid? The question is, how can investors make money on crude oil now? You will find answers here and also learn how to sell options in one of the biggest and best markets for writing option premium.
“Blood in the Streets”
It was Baron Rothschild who said, “The time to buy is when there’s blood in the streets…”
Oil prices have been so low, for so long that the blood is indeed starting to flow – both figuratively (in the US, Canada and Russia) and literally (in the Middle East). If the Baron were alive today, he might be reaching for his billfold.
Oil bulls have been “picking the low” in oil prices for a year now. For the most part, that has not worked out so well. Oil prices are down 45% since this time last year. A number of big name hedge funds are down sharply in 2015 – due in no small part to long oil bets. Big money managers such as Fortress Investment Group LLC are closing long time funds, while industry giants such as David Einhorn’s Greenlight Capital Inc. are posting double digit losses on the year. (*source: The Wall Street Journal)
Despite the big shooter’s attempts to “buy low”, oil prices have remained, with the exception of last year’s winter rally, stubbornly depressed. This has been primarily because of three factors:
Reasons for Low Oil Prices
1. Burdensome Global Inventories: Global Oil supplies in both the US and World currently classify as a “glut” at are at record highs. At the time of this writing, US weekly ending stocks sit at 460 million barrels – 28% above the 5 year average.
2. Global Inventories Have Continued to Grow: This is the crux of the bear argument. Even as US producers pull back on production, the rest of the world is not. The oil market is a global game. That point became abundantly clear last March when OPEC rattled oil markets with its announcement that it would not only not cut production, it would increase production. In August, OPEC production hit 31.5 million bpd – above its target of 30 mbd. OPEC producers refuse to scale back as each member fears doing so would result in loss of market share to others who would not.
Despite US cutbacks, global oil supply has continued to grow.
As a result, global oil supplies are expected to hit 93 million barrels per day in 2015, an all time record.
3. Iran Nuclear Deal: The finalization of the Iran Nuclear deal is expected to result in Iran doubling its oil exports to 2.3 million barrels per day. Bears have been hand wringing for months about the effects of an extra 1 + million barrels of oil hitting the world market.
Indeed, with the budgets of Middle Eastern countries such as Saudi Arabia, Iraq, Iran and Oman predicated on $90 to $100 oil, oil prices at current levels for an extended period could certainly lead to “civil unrest.”
However, as Robert DeNiro once said “Theres a flip side to that coin.”
Low Prices Curing Low Prices?
While the current oil glut is what has grabbed headlines in recent months, the rebalancing of the crude oil market is already well underway. At some point, Economics 101 dictates that low prices will eventually cure low prices. The key evidence of this taking place includes:
1. US production falling: There is nobody low oil prices have hit harder (with the exception of the Russian economy) than US oil frackers. US production has dropped 500,000 barrels per day since peaking at 9.6 million barrels per day (mbd) in April.
Albeit after a massive run up since 2012, US Crude production dropped noticeably in mid 2015.
The EIA projects US production dipping by another 500,000 barrels per day by August of 2016. Now the world’s largest producer of oil, the US and its production cutbacks are at the core of the bull argument. According to John Hess, CEO of Hess (HES) “The seeds have been planted for a slow recovery in oil prices.” Hess says global E&P investment has fallen to $550 billion from $700 billion a year ago.
OptionSellers.com projects a major low in the oil market in late 2015, early 2016.
The oil industry expects to see continued consolidation in the US. At current prices, about 1/3 of US producers have the pockets to ride out the downturn. Another third are struggling. The bottom third is in trouble. Industry sources suggest that if prices remain at sub $60 levels through Q4 2015, bottom third members will begin to pull out in numbers.
2. Demand: Despite a lackluster global economy, lower prices are spurring demand for crude. The The IEA expects global demand growth of 1.7 barrels a day in 2015, the fastest pace in five years. Demand is expected to jump another 1.2 barrels per day in 2016.
3.Seasonal Tendencies favor Bulls: It is not unusual for slack seasonal demand to weigh on oil prices during autumn. However, as early as December, refineries tend to switch back to gasoline production to start building inventories for summer demand season. This has historically (although past performance not indicative of future results) resulted in surging crude demand and often corresponding price increases beginning in December. This demand effect can and last deep into the Spring.
Outlook and Strategy
Despite the current supply picture, US production cutbacks along with surprisingly robust global demand will likely offset any production increase from Iran and begin to chip away at the global oil surplus. We may finally be seeing the tipping point in oil market fundamentals. With the expectation of more US producers folding into 2016 and a strong seasonal tendency for prices to trend higher into Spring (US producers were pumping over 2 million barrels per day more last winter when prices climbed above $60), OptionSellers.com projects a major low in the oil market in late 2015, early 2016.
Nonetheless, while we’d like to oblige the Baron, I’m afraid we’re not that bold.
Crude Oil (daily continuation)
Selling puts with strikes in the 20s would seem to be a solid strategy for taking advantage of shifting oil market fundamentals without having to pick the low.
We’re not predicting a new raging bull market in oil. Rather a gradual firming of prices into spring.
In addition, “buying low” requires timing. It can also require steel nerves and stubborn determination. As an option seller, you don’t need to bring those traits to your investments. Instead, view additional November or December weakness in Crude Oil prices as opportunities to begin targeting put option premium with strikes in the 20s.
For instance, another $2 -$3 drop in the price of crude would make solid premiums available at the $28 per barrel strike price. If you sell a put option with a strike at $28, that option will eventually expire worthless – as long as crude oil remains ANYWHERE above $28. If it does, you keep the premiums.
That beats trying to time a low. And it puts you in position to take advantage of seasonal demand – even if it only serves to stabilize prices.
The “blood in the streets” is real in crude oil. That doesn’t mean you have to buy it at market prices. If you can get long from $10 to $15 below the market price, you help protect yourself from spilling any of your own. And you get much higher odds of success.
That’s a proposition the Baron surely would have appreciated.
(OptionSellers.com provides a fully managed option selling portfolio that allows investors to sell options in a variety of uncorrelated markets including crude oil, gold, soybeans and sugar. For more information on managed accounts for high net worth investors, call 800-346-1949 or go to www.OptionSellers.com/Discovery to request an Investor Information Kit. Qualified investors may also schedule a free consultation by calling the number above.)
***The information in this article has been carefully compiled from sources believed to be reliable, but it’s accuracy is not guaranteed. Use it at your own risk. There is risk of loss in all trading. Past performance is not necessarily indicative of future results. Traders should read The Option Disclosure Statement before trading options and should understand the risks in option trading, including the fact that any time an option is sold, there is an unlimited risk of loss, and when an option is purchased, the entire premium is at risk. In addition, any time an option is purchased or sold, transaction costs including brokerage and exchange fees are at risk. No representation is made that any account is likely to achieve profits or losses similar to those shown, or in any amount. An account may experience different results depending on factors such as timing of trades and account size. Before trading, one should be aware that with the potential for profits, there is also potential for losses, which may be very large. All opinions expressed are current opinions and are subject to change without notice.