Government shutdowns, geopolitical angst, protracted instability inside the Beltway, and outright market manipulation are combining to make this a profoundly volatile, unsettling time.
On Wednesday, for instance, both West Texas Intermediate (WTI), the benchmark crude rate set in New York, and Brent, the more widely used oil trading standard set in London, spiked ferociously – more than for any one session in well over a decade. WTI ended trading up by 8.7%; Brent by 8%.
With these spikes coming after historic price declines, everyone in the media is now looking for the oil price “floor” that can enable steadier upward moves.
I don’t expect that floor to be a factor until into 2019. Year-end tax sales, low holiday volume, and institutional portfolio adjustments mean any floor, if it shows up, probably won’t register until January.
And yet, these kinds of violent swings can be remarkably profitable. Late last week, my Energy Inner Circle readers following along got the chance to close out a 1,000% profit on a Brent “straddle” – a call and a put expiring on the same date at different strike prices – that saw us play the “up” and the “down.”
There are three things in play right now obscuring the “floor” and keeping crude prices untamable, but that will ultimately give way to a much smoother, upward price trend…
Here’s Why Oil Is So Volatile Right Now
As I said, folks following along with my recommendations to ride the volatility are enjoying a good month.
But the broader crude markets are still on course to finish the worst month since the beginning of the meltdown 10 years ago.
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There’s little reason to expect sentiment to improve in the short term.
That’s largely down to the historic weakness in stocks – fresh off the worst Christmas Eve ever, and a series of 1,000-point whipsaw moves up, down, and up, although the selling wasn’t quite so violent on Friday.
Also keeping a damper on crude sentiment is the fear than an inversion in the yield curve will prompt a further decline in bond prices.
In my opinion, this fear is at least somewhat overblown, though there are legitimate concerns. The analysts forecasting “Bond Apocalypse ’19” are the same guys who’ve correctly predicted five of the last two recessions.
But largely, underwhelming crude sentiment is being caused by crude prices themselves.
Despite last week’s impressive rally, both oil benchmarks remain well down for the month, thanks to overreaction in the absence of hard data and some cases of outright manipulation.
Additionally, the spread between the two remains above 15% of the difference as a percentage of WTI (the more accurate way of measuring it) and has been at double digits in each of the trading sessions since Sept. 20.
So let’s take a look at the “real” price of oil…
The Truth (in Crude Pricing) Will Set Us Free
You might recall, I use an algorithm to track the genuine price of oil – where the trade in wet barrels (actual consignments of physical oil available for delivery) would value the crude absent short, derivative plays, credit spreads, “phantom” barrels (booked but strategically appearing or disappearing in advance of settlement).
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In essence, this algorithm gives us the price that oil ought to be valued at, once the manipulation is stripped away.
Based on my calculations at close Friday, the effective crude price (ECP) should be $54.50 for WTI and $66.20 for Brent.
These are 17.9% and 21.5% higher than the market’s closing prices – and that’s after last week’s huge gains.
Let’s put this in perspective.
It’s a Long, Scary Ride… but It Will End Soon
WTI and Brent reached their most recent highs on Oct. 3. Since then, they have lost 39.5% and 37%, respectively. A very cursory, back-of-the-envelope view would tell us that well over 40% of both those benchmark dives has been artificial.
Now, that still leaves a genuine decline.
But there are two critical things to keep in mind as we go forward. They’re critical because, aside from straddles like the one that got us our 1,000% winner, they’re the key to profiting in this wild market:
First, the manipulation cannot be sustained in the face of rising prices, because much of this requires a declining underling price to sustain profits, once the forward curve (extending prices out over time, generally using what is called the “NYMEX strip”) starts moving into contango.
That’s when the forward price of oil is higher than the current (or spot) price. If I actually buy physical oil, that would provide an advantage – I would be buying cheap and allowing a later sale at profit. But if I am running futures contracts – “paper barrels” – it would serve to shrink estimated profits.
The result is those parlaying paper and wet barrels would start moving the near-term price higher.
As that trend develops, it requires an unraveling of shorts and related moves based on the need for prices to continue declining.
The market price then increases acceleration.
The other thing to remember – and this is already emerging with oil-related stocks – is their appreciation will move up well in advance of the market as a whole. This flows from the simple fact that the sector is already significantly oversold.
This is more than just the recipe for making profitable oil moves now – moves I’ll be recommending for my paid-up subscribers – but it’s a sure sign that the white-knuckle roller-coaster ride will end before much longer.
We just need the dust to settle first and let the roller coaster come to a stop.
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