Three Powerful Fundamentals Suggest Troubled Waters for Crude Oil Prices Ahead
Here is How Option Sellers can Take Advantage Now
In December of 2015, the pundits were abuzz with talk of crude oil going to $15, maybe even $10 per barrel. OptionSellers.com predicted on CNBC (www.OptionSellers.com/media ) in late December that prices would top $50 as the US approach Driving Season this year.
We didn’t quite make it all the way there. But oil prices have seen an impressive rally nonetheless. Why?
Analyst will give you a number of reasons. But the real reason is likely the one they are least apt to talk about – the seasonal tendency and fundamentals behind it. My outlook then was that oil prices would climb this Spring because refineries ramp up gasoline production in the Spring to accumulate inventory for summer driving season. It remains our opinion that this was the primary driver of crude prices during the first part of 2016.
Its not rocket science guys.
But we are nearing the apex of that seasonal tendency. That combined with a couple of strong supply side fundamentals has us now projecting that crude oil prices will have a hard time trading substantially higher (money call) and potentially push back into the mid to low 30’s by Fall (media call.)
3 Strikes for Crude
Here are the 3 Main Reasons We see Crude Unlikely to climb substantially higher in the months ahead
- Powerful Seasonal Tendency: It used to be, in years past, that crude oil prices could show strength right up through peak driving season in June and July. But with the oil landscape changing, ushering in a new era of higher global supplies, the seasonal tendency has been to break earlier – often as early as late April or early May. Why? Because high crude supply means adequate gasoline inventories can be achieved sooner. Supporting this outlook, EIA gasoline stocks currently stand at 13.913 barrels above levels last year at this time and a considerable 25.478 million barrels above the 5 year average. Yet, the refinery operating rate stands at 89.4%, compared to 91.2% last year. More supply and lower refining rate indicate driving season inventories are likely close at hand.
Caption: Crude Oil prices have tended to break earlier in the season in recent years.
- US Stockpiles at 100 year highs. Current US Crude Oil supplies are near their highest levels in history. EIA crude stocks are currently 49.609 million barrels above year ago levels and 136.331 million barrels above the 5 year average. Burdensome supply is what dogged prices for much of 2015 and will likely help keep a lid on prices in 2016. With refineries likely beginning to throttle back this month, don’t expect these levels to wane much this summer.
Despite domestic production cutbacks, US crude stockpiles have reached historic levels
- Collapse at Doha: In another effort to curb OPECs nonstop gusher of oil that continues to flood the word market, OPEC members met in Doha this past month to try to set new limits on production. To make a very long story short, it didn’t end well. The Saudi’s balked at the last minute, insisting that Iran must participate as well, or there would be no deal. As everyone in the thinking world knows, that aint’ gonna happen. Iran is eager to catch up in oil revenue after years of sanctions and will likely increase its already 3.5 million barrels per day (bdp) oil production to hit pre-sanction levels by this summer. And they are not known to work and play well with others, especially those that oppose their ideological as well as imperial agendas (such as Saudi Arabia.) The bulls were hoping for a deal and we may still get something resembling one down the road. For now, however, the wind is out of that sail.
Conclusion and Strategy
Bulls trying to paint a happy face on the collapse at Doha have talked about how this failure to curb production as “good” for longer term prices – allowing the market to “re-balance naturally.” That is code for more price pain coming soon to an oil producer near you.
December 2016 Crude Oil
Selling December Crude Oil 67.00 Call Options
There are, of course, arguments to be made for higher prices. US production has scaled back significantly in the past 24 months. Global demand is rising, despite sluggishness in many top economies. And it’s possible OPEC manages to put some kind of deal together this year – even if just on paper.
That being said, it will likely be 2017 before any real supply “rebalancing” takes place in crude – assuming the world doesn’t spin into another recession before then. Supplies, both US and global remain burdensome. A strong seasonal tendency lower into driving season should keep pressure on crude oil prices this summer.
Our clients have begun selling call options at or above the $76 strike price and collecting attractive premiums in doing so. That way, crude prices can move a number of ways. However, if they are anywhere below $76 at option expiration, the options will expire worthless and the investors will keep the premiums as profit.
If you trade on your own, you might consider the December Crude Oil $67 strike for premiums of $600 or higher.
Do not misinterpret our outlook. This market can still rally – especially if talk of another OPEC meeting pops up next month. But moving substantially higher will be extremely challenging for this market – which is why it appears to be ideal for call sellers at this point. Additional strength this month can be viewed as opportunities for adding to positions at higher strike prices.
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James Cordier is co-author of McGraw-Hill’s The Complete Guide to Option Selling, 3rd Edition. He is also founder and head trader at OptionSellers.com – a private capital management firm specializing exclusively in selling options. For more information on managed option selling accounts with James Cordier and OptionSellers.com, you can request a Free Investor Discovery Packet at www.OptionSellers.com/Discovery.
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