Three Factors IMPACTING Oil in the Coming Months

• November 3 is a significant day for the oil market

• A COVID-19 vaccine and the return of pent up demand

• The economic legacy of 2020 could become a powerful force for the energy commodity

The path of least resistance to the price of crude oil is a complex jigsaw puzzle. Many factors determine if the price of the energy commodity that still powers the world will rise or fall. In April 2020, we saw the demand for petroleum evaporate as the global pandemic spread around the globe. The price of nearby futures on NYMEX dropped below zero as storage facilities filled. The price of Brent crude oil, more seaborn petroleum, fell to its lowest price of the century at $16 per barrel.

OPEC, Russia, and other world producers cut production by almost 10 million barrels in an unprecedented move to balance the fundamental supply and demand equation. US output dropped because of the falling price that made output a losing proposition for oil companies. The price of crude oil recovered to the $40 per barrel level, where it has been consolidating since early June.

2020 has been anything but an ordinary year. With crude oil sitting at a $40 pivot point, the events of the coming weeks will determine the path of least resistance for the price of the energy commodity over the rest of this year and into 2021. The United States Oil Fund (USO) moves higher and lower with the price of crude oil that trades on the CME’s NYMEX division.

November 3 is a significant day for the oil market

The price of crude oil has been trading around $40 per barrel level since early June.

Source: CQG

As the weekly chart highlights, the crude oil futures market on NYMEX has been in a sideways trading pattern since the beginning of June. The sharp rebound from the downside spike to below negative $40 per barrel created an $80 per barrel swing. It took the NYMEX futures less than two months to fall from $40 to the low, and the consolidation pattern is now six months old.

The outcome of the November 3 US election will determine the future of fossil fuel production when it comes to regulations and government support for oil producers. For decades, US policy has mostly focused on achieving energy independence from the Middle East. Over recent years, the United States surpassed Russia and Saudi Arabia as the world’s leading petroleum producer. The fracking process caused output costs to decline, and fewer regulations under the Trump administration turbocharged production. If the President wins re-election and the Senate remains in the hands of a Republican majority, we should expect a status quo approach to US energy policy. However, the Democrats are leading in the polls, and the potential of a sweep that includes the White House and Senate are high.

The Democrat’s progressive wing favors a ban on fracking and a shift from fossil fuels to alternative energy sources to power the United States. While former vice president Joe Biden has said his administration will not end fracking, he acknowledges that it will introduce a shift from the process. The position may not be fast enough for influential environmentalists on the left, who will put pressure on a new administration. The bottom line is that US oil production will decline under the Democrats.

While replacing hydrocarbons with other energy sources may be a noble pursuit in the eyes of many, the reality is the US and world continue to consume petroleum-based fuels. Any sudden increase in regulations could hand pricing influence from the US back to Russia, Saudi Arabia, and the international oil cartel, OPEC. US policy in the aftermath of the election could cause volatility over the coming years in the oil futures arena. It may even push the price of the energy commodity appreciably higher. At the same time, the downward trend in the dollar and the Fed’s encouragement of rising inflation are bullish for commodity prices, and crude oil is no exception. The outcome of the November 3 election is a significant factor for the oil market.

A COVID-19 vaccine and the return of pent up demand

The world is now experiencing the second wave of the global pandemic that began in early 2020. Some scientists expect that the number of cases and fatalities in the US and Europe will significantly rise over the coming winter months. The potential for shutdowns and slowdowns in businesses and a return of social distancing that causes people to remain at home are increasing. A short-term return of policies that drive the economy to contract would weigh on crude oil demand. It could send prices lower during the months when the energy commodity tends to experience seasonal weakness.

Meanwhile, after over six months of research and trials, the world is coming closer to a vaccine. Healthcare professionals have learned a lot about the virus over the past months, so therapies to treat the infected have improved outcomes. The odds of a vaccine that creates the kind of herd immunity that would allow life and business to return to normal and pre-COVID-19 levels are rising.

So long as governments provide the necessary stimulus to get people through the coming months, a return to everyday life would unleash lots of pent up demand for energy. More people will begin working and earning again. Travel and hospitality will make a comeback as the idea of a business trip, or vacation has become little more than a fantasy for many. A return to normalcy would likely support higher crude oil and oil product prices.

The economic legacy of 2020 could become a powerful force for the energy commodity

Perhaps the most significant factor for the coming years will be the impact of central bank liquidity and government stimulus. The US Fed told markets that short-term interest rates would remain at zero percent until 2023. Simultaneously, the central bank has moved the target on inflation higher. The need for liquidity will remain high long after a vaccine and treatments reduce the coronavirus risk. Government stimulus is increasing the level of debt at a dramatic pace. The bottom line is that both liquidity and stimulus increase the money supply and weigh on the value of fiat currencies. As the purchasing power of the dollar, euro, and other foreign exchange instruments decline, the prices of commodities are likely to rise.

From 2008 through 2012, we witnessed the impact of liquidity and stimulus on the raw material markets as many commodities rose from risk-off bottoms in 2008 to multi-year or all-time highs in 2011 and 2012. NYMEX crude oil futures fell to a low of $32.48 per barrel in 2008. By 2011, the price reached almost $115.

The economic legacy of 2020 could be the most potent force for the crude oil market over the coming years. While another significant wave of COVID-19 infections threatens to push the price of crude oil lower in the short-term, we should expect higher prices in the coming years. The extent of the move higher could depend on US production policy in the aftermath of the November 3 election.

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The United States Oil Fund (USO) was trading at $27.24 per share on Monday morning, down $0.64 (-2.30%). Year-to-date, USO has declined -73.42%, versus a 7.91% rise in the benchmark S&P 500 index during the same period.

USO currently has an ETF Daily News SMART Grade of D (Sell), and is ranked #66 of 113 ETFs in the Commodity ETFs category.