Oil Market Special – How Low is “Too” Low?

Oil Market Special – How Low is “Too” Low?
Feb

12

2015

Oil Market Special – How Low is “Too” Low?

tn-james-blog2

Crude Oil Supplies are Massive. Prices remain weak. But are current fundamentals now priced into the market? Here is the play for Option Sellers Now

To paraphrase a trader friend of mine, “If you liked it at $50, you’ve got to love it at $30.”

If you think oil prices could be reaching value levels near $50 per barrel, this months market special is going to show you how to own it at $30. But first lets talk about the reasons why it will probably never make it there.

Crude Prices Stabilizing?

In case you were on a submarine below the Artic ice for the past 12 months, the decline in oil prices has been the financial news story of 2014 and continues to dominate headlines in 2015.

In short, the story is, the fracking boom in the US, an unrestrained OPEC and slowing global economies. Shake well. Pour out a world oil glut. Result? Oil prices dropping by 57% in just the last 7 months their lowest levels since the great recession.

The story is primarily a supply one. Oil Supplies in the US hit a fresh record high last week at 413.06 million barrels. EIA crude stocks are 54.975 million barrels above year ago levels.

Yet prices appear to have hit a consolidation level between $45-$50 (Despite this week’s ill fated venture up to $54.). It’s hard to see the fundamentals getting any bleaker than they are now. But prices seem hesitant to push much below $45. Why?

While this is not an “its always darkest before the dawn” story, there comes a point where current supply is priced into the market and the market needs more bearish news to continue the trend. It is our opinion that the worst of the supply side story has been priced and the news over the next 3-6 months could be, how do we way “less bearish.”

What is Driving the Supply Glut?

In the accounts I manage, looking behind the news to uncover the core fundamental driving price is the key to uncovering option writing opportunities.

The first thing you should realize about the current glut in oil is the Saudi Arabia is driving the boat. It was the Saudi’s choice to ramp up production instead of cut back to support price last year. It is speculated they did this to accomplish 3 main objectives:


  1. Punish Russia for it’s support of Syria
  2. Punish Iran for it’s nuclear program
  3. Slow down the US fracking industry

One could argue it has accomplished all 3.

Russia’s economy is in shambles due to slashed oil revenues (amongst other things). Iran not as bad yet but getting there. As for US frackers, their eyes are watering.

Plummeting US Rig Count – How Low Prices Cure Low Prices

In the US, many fracking operations in the cannot survive with prices under $60 and recent data confirms it.

The US oil rig count has fallen by 24% in just the last 5 months (*Source: Baker Hughes).

For a more dramatic example, Canada’s rig count is down by over 65% since last year.

oil-rigs-on-land
The US Oil Rig Count has fallen by 24% since the highs in October to 1223 rigs

That trend will continue as long as oil remains below $60 and potentially below $70. This puts a dent into US production capability and will eventually start to choke off new supply of oil, allowing inventories to begin to draw down again. If you need a better example of how low prices cure low prices in a free market economy, look no further.

At the same time, fiscal budgets for the Saudis and their allies rely on oil prices at $70 or $80. They can get by at $60, but not at $45.

If you need a better example of how low prices cure low prices in a free market economy, look no further.

Thus far, they have been willing to take the short term pain to punish their enemies and pare back their competitors.

But they can’t take it forever.

January’s announcement by OPEC Secretary General el-Badri that oil prices will “go back to normal very soon” was more likely aimed at his unhappy OPEC members than anyone else

Seasonal factors favor Bulls

Near record supply builds in the US have not been helped by low refinery operating rates in January as refineries shut down for maintenance. Part of this maintenance is recalibrating plants towards gasoline production over heating oil production

US Refineries tend to ramp up operating rates in the Spring in an effort to boost gasoline inventories for summer driving season. This year shows early signs of increased operating rates.

EIA Weekly Refinery Operating Rate Current Year vs Last Year vs Average

In the winter months, refineries typically begin to ramp up production of gasoline in order to have enough inventory on hand to meet summer demand needs.

Indeed refiners seem to be eager to put excess crude supplies to work as operating rates climbed 1.9% last week to 89.9%. This compares favorably with rates last year at this time at 86.1% and a five-year average of 83.38%.

This ramp up in refining rate tends to increase demand for crude in the Spring and has historically tended to support crude prices (for a full discussion of using seasonal tendencies to select high probability option sales, see chapters 15 and 16 in The Complete Guide to Option Selling).

Higher Demand at Lower Price Levels

While global demand is flat, US demand for gasoline is strengthening at lower price levels as is evidenced by the chart below.

Gasoline demand is up in early 2015 due to both a recovering US economy and low gasoline prices.

EIA Gasoline Demand

Note 2014 demand surge as oil prices fell. Average total gasoline demand for the past four weeks was up 6.26% compared to the same period last year. This is a trend that should continue and likely be witnessed globally in 2015 (see The Big Picture column in the February newsletter.).

Outlook

In conclusion, we see the following four factors combining to support oil prices in the coming months:


  1. Falling Rig counts in North America beginning to curb US production (and discourage new rig operators)
  2. OPEC Suffering with price below $60, even with the Saudi’s responsible for the price pressure
  3. Oil Price decline of over 50% could be enough to price current fundamentals
  4. Global Demand beginning to increase as lower prices and recovering economies spur demand

Strategy

Does all of this mean oil prices are at a low?

Maybe. Maybe not

Don’t care.

As an option seller, you don’t have to involve yourself in such fruitless efforts as picking lows. It’s a fool’s errand. Believe me, I’ve been on it.

Instead, you want to put yourself in a situation to potentially profit from a variety of outcomes.

Your criteria as a put seller only requires oil prices to be getting near a low. Will it go to $40 as Goldman predicts? Or will it rebound as some oil analyst are now projecting? As an option seller, these aren’t really questions you have to ask.

The downward spiral in crude prices has spiked volatility for put options. At the time of this writing, you can sell a July Crude Oil $30 put for $450. For you to profit from this trade, all crude has to do is stay above $30 per barrel through June 17. Should it stabilize near current levels, rise above $50, or even slowly creep lower (but remain above $30), these options should still be nearly worthless in about 90 days. More conservative investors can wait for another pullback in oil and potentially sell for a higher premium.

July Crude Oil

July CRUDE OIL


Selling the July Crude Oil $30 put

Slightly more aggressive investors can look to sell the July $35 puts for $700-$800 premiums.

Selling puts at these levels allows you to profit from a wide variety of scenarios, even some not so bullish ones. It also empowers you to stop worrying about daily up and down ticks in the market and focus on the big picture.

Are oil prices at a low? They may or may not be. But our research has convinced us we are at least in the neighborhood of a low. While this does not necessarily mean oil prices are in for a sweeping reversal, it does mean it could be a good time for put sellers to go shopping.

That’s what we’ll be doing for our investors over the next several weeks. You may wish to do the same.

Have a great rest of the month in your premium collecting.

Learn How to Sell Options with the Authors – Free Discovery Kit

Are you a high net worth investor interested in selling options in Crude Oil and other commodities? You may be able to invest directly with James Cordier and Michael Gross, authors of McGraw-Hill’s The Complete Guide to Option Selling. For program details and to see if you qualify, request your FREE Investor Discovery Kit Today at www.OptionSellers.com/Discovery. ($250,000 minimum investment required)

Learn More about the Kit

James Cordier is the founder of OptionSellers.com, an investment firm specializing in writing commodities options for high net-worth investors seeking outsized returns. James’ market comments are published by several international financial publications and news services including The Wall Street Journal, Reuters World News, Forbes, Bloomberg Television News and CNBC. Michael Gross is an analyst with OptionSellers.com. Mr. Cordier’s and Mr. Gross’ book, The Complete Guide to Option Selling 3rd Edition (McGraw-Hill 2014) is available at bookstores and online retailers now.


Price Chart Courtesy of CQG, Inc.
Fundamental Charts Courtesy of The Hightower Report


***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.

  1. Shawn Jarrett Says:
    February 27, 2015 at 7:01 pm

    I’m so glad you guys started publishing again…

    You call them about 80-90% correct and I’ve learned, as your book says, that its all about money management !

    Thanks,

    SJ

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