Wednesday, October 26, 2016

Crude Oil; Impact Report - Bearish View

Inventories Down/Rig Count Up/Oil Prices Peaked…for now

Oil prices rose after Crude inventories were reported by American Petroleum Institute to have declined by 553,000 rather than increasing by 4 times that amount as expected, shocking traders and helping to push prices higher by more than a dollar instantly.  Below, I will argue this bullish development will not last long.

Efficiencies have lowered the hurdle rate at which output from many Shale production sites may profitably operate.  Rig count has grown by 38% from a low of 404 in May to 553 now, but still well below the September 2014 high of 1931.  Rig count continued to grow after crude oil prices peaked at $107.73 (rolling first future) in June of 2014 and where I wrote on June 24th “In Short: We have very likely already seen a high of the bullish advance in crude.

With domestic production capacities growing and the pink cloud from month-ago, OPEC sponsored output guidance, the bullish advance from sub $30 to last weeks, above $52 high seems even more ready for an extended pause at the least.

We noted last week that we had a hard time, ahem, ‘buying into’ a bullish formation on the weekly oil charts that projected a gain of $25 to a target of $77 (for chart, see link just below).  At the same time we wondered out loud how many traders were not willing to wait for that bullish formation to fully develop, if it indeed would, and instead jumped too early into ill-timed and wrong-priced longs.  And so with Crude trading at $51.70, we wrote; What level of disappointment is required in order that those ‘anticipatory’ longs exit positions?   We wonder further if that time is upon us. 

Net long positions held by ‘non-commercial’ accounts (often called ‘large speculators’ which include, but are not limited to hedge funds) are just 5% below the record high achieved back in June 2014 when Crude prices were peaking.  These account types increased their net long positions by 140,000 in three weeks as Crude approached last week’s $52 high.  The latest report, for reporting date October 18th, showed a very marginal decline in that net-long position. 

Another way I like to gauge market participation is by looking at open interest - the number of outstanding positions.  Crude oil futures open interest reached a record high on October 6th at 1.941M as price action was reaching toward $52.  As Crude failed to advance, and instead moved side way for the next week, open interest began to fall and continued to drop by 8% as Crude made its October 19th high.  Open interest has recovered somewhat into declining price action since.  From the above, we can surmise that ‘large spec’ accounts continued to build positions into recent high Crude price action in anticipation of further gains and the election of the aforementioned bullish formation targeting $77.