Seeds Being Planted for Big Move in Crude Oil

• The bearish case- Risk-off, gridlock, and seasonality

• The bullish case- Vaccines, stimulus, a shift in US production policy, and the Middle East

• A false break lower- A return to the midpoint- A reckoning because of the massive level of inflationary seeds from 2020

At the $42 per barrel level at the end of last week, the nearby NYMEX crude oil futures contract was sitting above the pivot point that has been in place since early June. The December crude oil futures price peaked at $4.33 over the $40 level in late August. In early November, it fell to $6.36 below the $40 pivot point. However, the trading range from $33.64 to $44.33 has contained the price action since May 29.

Markets are often like tightly coiled springs. They can trade in a price band for extended periods, but an explosion to the upside or implosion to the downside tends to occur when they finally move.

Crude oil demand has suffered during the global pandemic. OPEC, Russia, and other world producers have cooperated to cut output by 7.7 million barrels per day. The group is likely to extend those cuts for at least three more months before the end of 2020. US crude oil output recently stood at 10.90 mbpd, almost 17% below the peak level at 13.1 mbpd from March 2020. Meanwhile, there are signs that the current trading band could lead to higher oil prices over the coming months. The United States Oil Fund (USO) tracks the price action in a portfolio of NYMEX crude oil futures contracts. The UCO and SCO ETN products are short-term tools that magnify the price action in the futures arena on. the up and downside.

The bearish case- Risk-off, gridlock, and seasonality

When crude oil fell below $0 per barrel and under negative $40 in late April, the risk-off environment caused by the global pandemic made the demand for the energy commodity evaporate. The rise in the number of cases and hospitalizations in Europe and the US threatens another risk-off period if the COVID-19 cases continue to rise over the coming weeks and months. Lockdowns and increased social distancing requirements worldwide would cause the demand for crude oil to decline.

Source: CQG

The chart shows that the price of active month January NYMEX crude oil futures fell from $42.15 on October 20 to a low of $34.04 on November 2 as virus cases rose.

Meanwhile, the majority in the US Senate is still up for grabs in the aftermath of the November 3 election. Voters in Georgia will go to the polls on January 5 to elect two senators. With the balance of power at 50 seats for Republicans and 48 for Democrats, if the Republicans win one of the seats, Kentucky Senator Mitch McConnel will remain the Senate majority leader. The Biden administration and House of Representatives will need to compromise on legislation. The bottom line is that gridlock in the US government would not allow for dramatic energy policy changes. Oil and gas production would likely continue, albeit with more regulations.

Finally, over the coming weeks, seasonality is likely to weigh on the price of crude oil. Since gasoline is the most ubiquitous oil product and drivers put fewer miles on their cars during the winter months, oil and gasoline prices tend to reach seasonal lows during the winter months.

The bullish case – Vaccines, stimulus, a shift in US production policy, and the Middle East

The bullish case for crude oil comes from science, government, and the geopolitical landscape.  After reaching the low on November 2 at $34.04, January futures put in a. bullish reversal on the daily chart on the day before the US election and added to gains on November 9.

Source: CQG

Pfizer’s November 9 news that its coronavirus vaccine was 90% effective lifted the NYMEX oil futures price to a high of $43.33 on November 11. After correcting to just above the $40 pivot point on November 13, the energy commodity took off on the upside once again on Monday, November 16, when the trial on Moderna’s vaccine was 95% effective. A vaccine would return life to some sense of normalcy, which is bullish for the crude oil price. January futures settled at $42.42 per barrel on Friday, November 20.

Meanwhile, long after the virus fades into memories, we will still be paying for the unprecedented level of central bank liquidity and low-interest rates. Government stimulus has already caused the US Treasury to borrow a record $3 trillion in May 2020, and more borrowing is on the horizon. Liquidity and stimulus increase the money supply and national debt, and it weighs on the purchasing power of currencies. The policies are highly inflationary, an economic condition that the US central bank is encouraging by raising their 2% target rate to an average of 2%. While the difference may seem subtle, it is not. Rising inflation and a falling dollar are bullish for all commodity prices, and crude oil is no exception.

If Democrats find a way to win both Senate contests in Georgia, it would hand the majority leader gavel to New York Senator Chuck Schumer and give the incoming President’s party a clear path for legislation. A majority in the Senate would pave the way for a far more progressive agenda that includes limiting or banning fracking, causing US natural gas output to decline substantially. Lower production would likely lead to higher prices.

Finally, the Middle East remains home to more than half the world’s petroleum reserves and is still the most turbulent political area on the earth. Any problems in the region that impact production, refining, or logistical routes would push prices higher. A dramatic shift in US production policy could hand control of crude oil prices back to OPEC and Russia.

A false break lower- A return to the midpoint- A reckoning because of the massive level of inflationary seeds from 2020

January crude oil fell below technical support at the October 2 low of $37.30 and the June 12 bottom of $35.94, when it reached $34.04 on November 2. The price stopped 42 cents shy of the May 22 $33.62 low.

The bullish reversal on November 2 pushed the price back into a bullish mode and above the $40 pivot point. January futures came within $1.26 of the August 26 high and was trading at $42.42 per barrel at the end of last week. A close above $41.70 on the nearby NYMEX futures contract on November 30 would put in a bullish reversal on the monthly chart, which could ignite a technical rally that takes the energy commodity to a new high, and the highest price since early March.

Meanwhile, the central banks and governments have spent the greater part of 2020 fighting the economic fallout from COVID-19 with liquidity and stimulus, which are inflationary seeds. 2020 is looking a lot like 2008 when it comes to three factors. However, this year, the stakes are higher.

Central bank liquidity is at a greater level than one dozen years ago, and today’s government stimulus dwarfs the amount in 2008. Moreover, in 2008, the US elected Barrack Obama as the forty-fourth President of the United States. In 2020, his Vice President, Joe Biden, became the forty-sixth, President-elect. In 2008, crude oil found a bottom at $32.48, but in 2011 the price reached $114.83. After falling to negative $40.32 in March 2020, the upside could be explosive over the coming years, given the similarity between policies in 2008 and 2020. However, in 2008 there were no plans to reduce US output, making the coming years even more interesting.

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The United States Oil Fund (USO) was trading at $29.60 per share on Monday morning, up $0.33 (+1.13%). Year-to-date, USO has declined -71.12%, versus a 12.46% 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 #73 of 113 ETFs in the Commodity ETFs category.