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The final quarter of 2018 has certainly been “historic.” Then again, so was RMS Titanic’s last night above water.
Both primary crude benchmarks posted highs on Oct. 3, but through close of trade on Dec. 27, they’ve been in marked retreat. West Texas Intermediate (WTI), the standard for futures contracts set in New York, has lost 41.6%, while Brent, the more widely used global yardstick set daily in London, has shed 39.8%.
Those figures even include a major single-session advance of 8% recorded on Dec. 26.
Of course, oil has been moving in tandem with a collapsing broader stock market. Weakness and volatility have been boosted by (largely misplaced) angst involving a credit inversion, where shorter-term maturities begin offering higher yields than paper further down on the curve.
A yield inversion is sometimes regarded as a precursor to a recession, although I also regard this fear as quite overblown.
Why? It’s simple: The market has had more inversions not leading to recessions than it has had those resulting in one. Besides, in the unlikely event a recession hits this time around, it usually takes at least 18 months for any tangible indicators to form. Prior to that, it’s all idle speculation, guesswork, and worry.
And as if to put a point on it, that worrisome inversion has quietly corrected over the past few weeks.
At the end of each year, there is a combination of loss-taking for tax purposes, institutional investors balancing and re-balancing portfolios, and lowered liquidity.
This is nothing new. This year, however, all three factors have collided in a profoundly uncertain environment fueled by a government shutdown, geopolitical tensions, concerns over U.S. foreign policy consistency, a U.S.-Chinese trade war, and highly suspicious computer-buying programs.
So it’s easy to see why crude prices seem stuck in the basement – stock prices, too, for that matter.
But as I’m about to show you, the year ahead looks much brighter than the current situation suggests…
First, We Need to Know the True Current Price of Oil
I’ve written at length about all the things that have to happen to assign a dollar price to a barrel of crude, be that a physical, “wet barrel” or a “paper barrel” futures contract. There’s a long list of external ingredients, if you will, many of which are vulnerable to manipulation.
Here is the bottom line on all of this:
Oil prices are currently sitting at some 18% (WTI) and 21% (Brent) lower than where my proprietary algorithm tells me the effective crude price (ECP) should be. That means what has developed is a massively oversold market, fueled by hype rather than underlying fundamentals.
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This is true both for oil as a commodity and for companies drilling, producing, transporting, or refining it.
Still waiting in the wings to affect the price are the same factors that should have led to a rise in price as we moved into November:
Renewal of Iranian sanctions…
The acceleration of the Venezuelan production collapse…
A civil war crippling exports from Libya…
At least 300,000 barrels a day being withheld form the market by Canada on pricing concerns…
And a rising debt burden among the more cash-strapped U.S. producers and production cuts kicking in from OPEC and Russia. This OPEC-Russia move translates into an additional 1.4 million barrels a day taken out of the market.
Word on the street now is that the Saudis are drafting an additional unilateral cut, although that may be essentially canceled out by a rising Russian problem with maintaining historically high production levels.
So, here is where I believe we should be in 11 months or so…
Oil Investors: Get Ready for an “Interesting,” Profitable 2019
The first quarter of 2019 should see an improvement to $50 for WTI and Brent to $57 or a bit higher.
That’s where it’s likely to get interesting.
Assuming the White House does not cut another mid-year exemption for the eight primary importers of Iranian crude – a politically motivated pre-election “prank” the last time around – there will be some major additional export volume taken out of the market.
An additional round of exemptions at this point would essentially scuttle the sanctions as a realistic tool, making them little more than another exercise in political theater.
But there is a very real problem here: Port and infrastructure capacity concerns limit the ability of U.S. exports to make up much of that difference.
And then there is this…
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We have a global supply shortfall approaching by the middle of 2019, a development now reported by International Energy Agency (IEA) and OPEC analysts, buttressed by the clear opinions in my network of sources.
My regular contacts are suggesting, by July 31, a price of $75 a barrel of WTI, with Brent coming in at $85.
Or in other words, where the market was in the first week of October 2018.
In the aggregate, that’s a very aggressive move up from where we are now.
My own read suggests a slightly lower price – $70 to $72 for WTI; $82 for Brent – may be more appropriate. But the price should be moving up nicely in any event.
The spread between WTI and Brent, however, should remain much larger than usual, with Brent prices coming in at 10% or more when the difference between the two benchmarks is calculated as a percentage of WTI – the more accurate way of determining the spread.
You can safely put this down to the fact that Brent is more susceptible to geopolitical events than is WTI.
Those concerns will remain, and anything increasing the availability of supply will simply move the price higher.08
There are two basic ways to cash in and go along for the ride here:
One is the United States Oil Fund (NYSE Arca: USO), which tracks the price of WTI. It’s simply the easiest way to go “long” WTI.
Then there’s the United States Brent Oil Fund LP (NYSE Arca: BNO), which of course tracks the price of Brent crude. My Energy Inner Circle subscribers got my recommendation for a BNO “straddle” – a call and a put expiring on the same day at two different strikes – and got the chance to reap a 1,000% payday.
Such are the profits possible in a volatile oil market. When conditions are good and prices move up, the potential gains can be even bigger.
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