According to the weekly Commitment of Traders (COT) report issued by the Commodity Futures Trading Commission (CFTC), crude oil drillers have sold the most forward production since oil was trading at more than $100 per barrel. Considering that drillers are willing to sell just as much at half the price and that the recent rally to $50 per barrel has been purely speculative, how low will prices go once the speculators get forced out and the producers’ selling drives the market lower?
Crude oil touches nearly every part of our lives throughout the day. The more we do, the more we use. This is what makes crude oil such a valuable economic forecasting tool. This week, we’ll look at the big picture in crude oil using technical, fundamental and spread data to explain what the market is telling us as we head into the summer months.
These trades in RBOB unleaded gasoline futures going back to October are a good example of using the Commitments of Traders report to spot turning points in the market.
This unleaded program is one of 35 markets followed. Register at CotSignals.com to see the Tradestation reports and combine the programs into a single equity curve for your evaluation.
This year began with a bang. Our forecasting models accurately predicted many of 2016’s early commodity rallies in metals, energies and grains. Our models also expressed the notion that while these rallies would be sharp, there was little evidence to suggest that this was anything more than a temporary spike in a deflating global economy. Therefore, the persistence of these rallies has been the biggest surprise of the year. However, the same factors that have led us to believe that these rallies would be temporary have only increased their alarm. This week, we’ll examine the primary component of our deflationary argument while also shedding some light on an inspired tweak to an existing measure of global economic activity.
The El Nino event of 2015 is expected to become the strongest on record. Considering the impact this event is supposed to have on our southern states, it’s time to review what has happened in the past as well as what may be coming. We’ll let the National Oceanic and Atmospheric Administration (NOAA), finish our intro. From NOAA’s analysis of the 1997 event. “The winter of 1997-1998 was marked by a record breaking El Nino event and unusual extremes in parts of the country. Overall, the winter (December 1997- February 1998) was the second warmest and seventh wettest since 1895. Severe weather events included flooding in the southeast, an ice storm in the northeast, flooding in California, and tornadoes in Florida. The winter was dominated by an El Niño influenced weather pattern, with wetter than normal conditions across much of the southern third of the country and warmer than normal conditions across much of the northern two-thirds of the country. ”
I was fortunate enough to be interviewed for a Wall Street Journal heating oil story last week. The primary question was, “How high can prices soar?” Supplies have tightened up considerably during Mother Nature’s onslaught and another bout of cold weather is hitting us, pushing prices higher yet again. Short-term demand related issues like the ones we’re experiencing now due to the weather are never a reason to jump into a market. My less than sensational outlook on current prices pushed me to the closing section of the article. This week, I’ll expand on the topic by looking at the diesel and heating oil markets and formulating a trading plan for the current setup.
The recent bout of record breaking low temperatures has led to an obvious increase in the demand for natural gas and pushed delivery prices up to $4.40 per million metric British thermal units (mmbtu). These are the highest prices we’ve seen since the heat wave and drought from the summer of 2011. In fact, the Energy Information Administration reported the largest natural gas draw for the week of December 13th since they began tracking it in 1994. Furthermore, many analysts expect to break this record yet again with this week’s report. However, in spite of the recent strength in the market, I believe that there are several structural reasons why this rally won’t last and that the pricing of forward natural gas will head lower from here.
The global energy market recently passed two milestones. First, China passed the US as the number one importer of crude oil in the world in September. Second, the US passed Saudi Arabia as the largest fossil fuel producer in the world last week. Neither of these incidents came as a surprise. Both trends have been progressing roughly as expected. However, now that we’ve reached critical mass in forcing the evolution of the global energy markets, it’s time to take a look at some of the longer-term changes that will arise as a result of these events.
China was destined to become the number one energy importer due to its population growth, economic growth and geography. While we are concerned about whether the effects of the government shutdown may trim two percentage points off of our third quarter GDP of less than 2%, the Chinese have been chugging along at GDP near 8% and haven’t seen their Gross Domestic Product drop below 6% since 1991. The economic boom in China is still in full swing. Speculative phases like warehouse space or production facilities may have been overbuilt just like their housing markets but the infrastructure buildup remains in full force. The governmentally sponsored projects continue to redefine the Chinese way of life through the addition of roads, bridges, trains and power plants.
The growth in China comes as we isolate ourselves here in North America. China is still our second largest trade partner. Most of our trade with them is at the cheap manufacturing level. Meanwhile our number one trade partner has become Canada. Our trade with Canada is much nearer to equal than our Chinese trading relationship. According to the July, 2013 US Census, our trade with Canada occurs at a 7% deficit while we import 280% more goods from China than we export to them. Our growing isolationism can be confirmed since Mexico is our third largest trade partner.
This brings us back to Saudi Arabia and energy production. There are two main reasons for our declining ties to Saudi oil. First of all, American vehicles have become more fuel-efficient. The University of Michigan tracks average fuel efficiency of all new cars sold on a monthly basis. There has been a 20% increase in the fuel efficiency since 2007. Furthermore, the, “Cash for Clunkers” program took approximately 700,000 inefficient vehicles off the market further adding to the overall efficiency of our current fleet. Secondly, fracking and tar sands production have vaulted the US into the leading petro-chemical producer in the world. Saudi Arabia and Russia still produce more oil but our total distillate output has surpassed them.
These major trends will continue for many years into the future. The US is expected to become fully energy independent by 2020. Meanwhile, China will become increasingly dependent on world supplies. We used the following example in describing the growth of the Chinese hog market a few years ago and the comparison still fits. The Chinese story is all about developing a new middle class and putting newly disposable income into new hands. The first new expenses are better food, clothing and shelter. Moving up the ladder, the new middle class expands into luxury goods like cars and vacation travel. The average Chinese person uses about 3 barrels of crude oil per year. The average US citizen use more than 21 barrels per year. Clearly, this gap has room to close as the new Chinese middle class continues to westernize.
The growing demands of the Chinese middle class will change the way China conducts itself in global politics. Energy analysts at Wood McKenzie expect China to claim as much as 70% of the global oil imports by 2020. Therefore, at the same time the US becomes energy self-sufficient, China will become even more energy dependent. This will place them in a different role regarding global peace, especially in the Middle East, as unrest there will affect their country more than anyone else. This should cause China to continue to grow their military, especially their naval power and should have the unintended benefit of allowing us to scale back our military investments. Hopefully, the politicians here won’t spin this into another cold war as an excuse to renew domestic military investment
China’s growing need to purchase oil on the global market will force their hand in freeing up their currency to float. Trade partners will not do business in a currency that can be manipulated at the drop of a hat. Opening their markets and allowing their currency to float will encourage investment flows in both directions. Big picture analysis suggests that this could be the catalyst towards pushing China into the dominant super power role. They have the demographics and capital necessary to generate the need for currency reserves and open markets. The last thing to develop will be the political ties towards the Middle East oil producers and finally, armed services to guarantee their trade routes remain open.