Crude Oil Opportunity: Hurricanes Harvey and Irma Do Not Change Fundamentally Bearish Picture for Call Sellers

Crude Oil Opportunity: Hurricanes Harvey and Irma Do Not Change Fundamentally Bearish Picture for Call Sellers
Sep

7

2017

Crude Oil Opportunity: Hurricanes Harvey and Irma Do Not Change Fundamentally Bearish Picture for Call Sellers

Crude Oil Opportunity: Hurricanes Harvey and Irma Do Not Change Fundamentally Bearish Picture for Call Sellers

Despite recent media coverage of hurricanes, North Korea and other news, the crude market remains deliciously ripe for call sellers

By: James Cordier

Yikes! Atlantic Hurricanes?

“Prices will Soar!”

North Korean Missiles?

“Stock up on Oil!”

Heating Season on the Way?

“Buy it all!”

Oil bulls never seem to tire of reasons to buy the black gold. But as bulls dream of the glory days of $100 oil, the reality is that oil prices are probably breathing a last bullish gasp in what is looking like a languishing bear market. In fact, they could even see a precipitous fall long before Santa starts fueling up the backup tank in the sleigh.

It is bullish enthusiasm however, that is presenting potentially lucrative opportunities for call sellers in oil. This month’s Premium Sniper will explain why you might want to consider such opportunities for premium capture in your portfolio.

Media Hype: Hurricane Outages

The recent media coverage of Hurricane Harvey, and now Hurricane Irma has continued to keep crude prices in the news. As we noted in our last Bloomberg interview, the initial refinery outages in Texas brought a spike in gasoline prices and a bottleneck in crude supplies. With refineries now coming back online, crude prices are now bouncing a little. Irma appears unlikely to threaten Gulf of Mexico rigs at this point (the US is much less dependent on Gulf rigs these days anyway) and should not be a threat to oil supply. Thus the recent blip in oil prices does not change an otherwise fundamentally bearish picture in oil, as we discuss below.

Media Hype: “Dwindling” Crude Inventories

Crude Oil’s August blip above $50.00 per barrel brought out the bulls one more time with reasons the market should go higher. Cited were driving demand, falling inventories, OPEC cuts, even North Korea.

Perhaps all played a role in the late summer strength. Media, of course, likes to hype the ones that make good stories – even when the stories have little relevance to the longer term price of oil.


…the reality is that oil prices are probably breathing a last bullish gasp in what is looking like a languishing bear market.

For instance, one network fielded an analyst siting “dwindling crude inventories” as the reason for the rally. Its possible inventory reports brought in a few buyers. But it is summer demand season. Inventories are supposed to fall this time of year. The real science comes from putting draw and supply numbers into context. Its from taking these kinds of facts out of context where those that trade off the “news” can be misled.

The facts are that inventory draws are larger than last year. Supplies are lower than last year. But 2016 experienced never before seen levels of excess crude supply. 2017 numbers remain near those record supply levels. Current crude US crude inventories sit at 466.49 million barrels (mb.) This is approximately 5.3% below last year’s record levels this time of year.

But current crude supplies remain nearly 22% above the 5 year average for this time of year. They may be lower than last year, but supply can still be classified as a glut. And that is heading into a particularly precarious time of year for oil prices (more about that in a minute).

You read about the “dwindling inventories” myth here a couple months back. I’m publishing it again here now because you’ll still see it used by some analyst to support their bullish case (and likely positions) in the crude market. Now you’ll know all the facts.

Media Hype: OPEC Cuts

Media continues to pump the OPEC story as a possible catalyst for oil prices.

The hard fact is, The OPEC oil production cut is not having its desired effect of reducing supply . OPEC ramped up production to record levels prior to the cut making it a non-starter to begin with. However, they only addressed the production levels. EXPORT levels from OPEC nations reached a RECORD level in July at 26.11 million barrels per day (bpd) – continuing to add to the global oil glut.


It’s simply old fashion supply and demand. In energy markets, that often means seasonal supply and demand.

Should prices continue to sink lower this fall, OPEC cheating on quotas will intensify from already troublesome levels – especially from nations such as Iran. Thus, an already troublesome supply situation could begin to feed on itself, much like it did in 2016 prior to cuts.

Media Hype: North Korea

The media has had a field day with the North Korea story. While its relation to oil prices took a back seat, some bullish analyst did try to use the story to bolster their case. Crude prices, they argue, would surge on an outbreak of hostilities with North Korea. Rationing would begin, they argue, to support military efforts on the Korean peninsula.

North Korea Leader

While military action in North Korea remains unlikely, any such action would likely be a boon to call sellers in oil.


Poppycock . In the first place, despite the gleeful media coverage, military action against or from North Korea remains highly unlikely. Intensified posturing on both sides does not change that fact. Both the US and North Korea (who in no way would act without the blessing of its surrogate parent, China) know what is at stake.

However, in the unlikely event that a military action would take place, oil prices, along with stocks and many other asset classes would likely decline , perhaps drastically, off of concerns for the US and world economy. For call sellers, this would be a boon.

The Real Story in Crude

Despite media hype, the real story in crude is less dramatic. It’s simply old fashion supply and demand. In energy markets, that often means seasonal supply and demand.

traffic

Labor Day marks the official end of “driving season” in the US.


With the official end of “driving season” on Labor Day, crude oil now enters what is known as “shoulder season.” This is a lower demand period of the year when crude inventories begin to build again as refinery rates slow in response to weaker demand.

This weaker demand and rising supply has, in the past, often led to lower prices into early winter . This price tendency is illustrated in the seasonal chart below.

GRAPH: Feb Crude 5 yr seasonal

Crude Oil prices have historically tended to decline from late summer into early winter as demand falls and inventories begin to build again.(Past performance not indicative of future results)


While we fully expect this seasonal phenomenon to once again begin pulling prices lower, there are a couple of factors that could exacerbate the trend this year. They are:


  1. US Production is soaring, adding to already near record supply levels. With oil prices hovering near the $50 level again, US producers have ramped up production. US rig counts numbered 768 in August, over double the 372 rigs in production this time last year . Why? Higher prices. Oil at $50 per barrel makes US fracking a lucrative endeavor. In addition, many producers used price strength this spring and summer to establish hedges in oil at the $55 even $60 level. Thus, maximizing output can be quite profitable, regardless of what the spot price does. Currently at 9.43 million bpd, its possible US production will top 10 million bpd by the end of the year, adding to already burdensome supply levels.

    EIA Weekly crude oil production

    US Crude Production will likely top 2015’s record levels by the end of the year.


  2. OPEC Cheating Could Roll Prices: Production agreements are largely based on the “honor system.” And some members of OPEC do not always behave honorably. In fact, with evidence building that Russia is already exceeding quotas, OPEC member Iran is likely over limit as well. Should prices begin a seasonal decline in the fall, members could simply choose to ignore the agreement in an “every man for himself” grab for market share. This could potentially “tip” the market – potentially back into the $30s.

Conclusion and Strategy

While media types busy themselves with sensational stories, the real forces driving crude prices are high supplies and the beginning of a weaker demand season for crude. We feel the highest odds scenario is for a steady drift to the low $40’s by December with an outside chance of a “roll” into the $30’s.

Regardless, the least likely scenario would appear to be a severe and sudden spike higher in crude prices. Still mammoth supplies and tumbling seasonal demand should prove too much of a weight to allow oil prices to rally too far (although limited rallies are always possible).

As option sellers DO NOT try to predict the market but only bet against least likely scenarios, selling call options would seem to be the ideal strategy in the crude market at this time.

We’ll be deploying a number of call selling strategies throughout the fall to capitalize on the crude situation for our managed clients.

March 2018 Crude Oil

March crude 61.00 call option


Selling the March Crude Oil 61.00 Call Option


Self directed traders can consider selling the March Crude Oil 61.00 call option on limited September rallies. Target $500-$600 premium. With current margin requirement, a worthless option expiration would produce an approximate 35% ROI.

While media hype brings ratings, its old fashioned fundamentals that most often win the day in commodities. Use hard facts – NOT to try to predict the direction of prices, but rather, to only bet against the sensational. It’s a trusted way used by many to make a living in the markets.

To learn more about managed option selling accounts with James Cordier and OptionSellers.com, visit www.OptionSellers.com/Discovery to receive a Free Investor Information Kit

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