Crude Oil ‘Coiling Like a Spring’, Election Likely to Have Big Impact

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October 20, 2020 9:34am NYSE:USO

NYSE:USO | News, Ratings, and Charts
  • The energy commodity has a long history of taking the stairs higher and an elevator shaft to the downside

  • The $40 level reflects over four months of price consolidation

  • A referendum on energy policy for the world’s leading producer comes on November 3

At the end of last week, it was still Groundhog Day in the crude oil futures market as the price was sitting at around the $40 per barrel level on the nearby NYMEX futures contract. Groundhog Day was a movie starring Bill Murray in 1993, where every day turned out to be the same. Yogi Berra, the Hall of Fame Yankee catcher and armchair philosopher, said, “It’s deja vus all over again.” Since early June, crude oil has been sitting around $40 per barrel after recovering from its first negative price in history in late April.

The global pandemic caused the price of nearby NYMEX crude oil futures to fell to a low of negative $40.32 per barrel before moving around $80 higher to the $40 level, where it stalled. Crude oil can be a highly volatile commodity. The move to the lows came as demand evaporated during the spread of the global pandemic. OPEC, Russia, and other world producers dramatically cut output to balance the supply and demand equation. US production fell naturally in response to lower prices.

Meanwhile, the crude oil price could become a tightly coiled spring the longer it sits at $40 per barrel. From the time that crude oil began trading on the CME’s NYMEX division, nearby crude oil futures did not trade above $41.15 per barrel from the early 1980s until 2004. In 2008, the energy commodity reached an all-time peak of $147.27 per barrel.

Support for the active month November futures contract stands at $36.58 with resistance at $44.05. The midpoint is at $40.32 per barrel, and November futures settled at $40.88 on Friday, October 16. The market has traded within the current range since mid-June.

The United States Crude Oil Fund (USO) tracks the price of NYMEX futures higher and lower.

The energy commodity has a long history of taking the stairs higher and an elevator shaft to the downside

Commodities can be one of the most volatile asset classes. Crude oil is the energy commodity that powers the world and is a leading raw material market when it comes to liquidity and volume. Crude oil also impacts other commodity prices as energy is required for production. Higher oil prices increase the cost of output, and when petroleum declines, production costs fall.

Over the long term, the oil futures market tends to move slowly and steadily during rallies and becomes a falling knife when the price drops. The most dramatic example came in 2008 during the global financial crisis.

Source: CQG

As the monthly chart illustrates, nearby NYMEX crude oil fell from a record high of $147.27 in July 2008 to a low of $32.48 per barrel in December 2008. The drop of 78% in only five months is an example of an elevator shaft path of the energy commodity during bear market periods. Crude oil rose to over $100 in February 2011 as it took over two years to recover higher as it took the stairs to the upside.

The last example of the price carnage that has become typical in the oil futures arena came this year as futures fell from $65.65 in January to a record low of negative $40.32 per barrel in April, a decline of $105.97 per barrel.

This year’s drop was $9.12 less than the move lower in 2008, but it came in only three months and pushed the price of oil below zero for the first time. Since then, the price recovered to the $40 level, where it remained at the end of last week.

The $40 level reflects over four months of price consolidation

November NYMEX crude oil futures reached a low of $24.43 on April 22, $64.75 per barrel above the price of the continuous contract at that time. Contango or the steep forward premium in the oil market during the price carnage in April reflected the market’s supply glut.

Meanwhile, after trading to the April low, crude oil got back on the bullish staircase.

Source: CQG

As the daily chart highlights, it took from April 22 until June 5 for the November contract to reach the $40 per barrel level. The price continued to edge higher but only reached a high of $44.05 on August 26.

Since then, the price corrected to a low of $36.58 per barrel on September 8, which has stood as the low and technical support level as of the end of last week. In September and October, crude oil has been trading around the $40 level, which has the pivot point for over four months.

A referendum on energy policy for the world’s leading producer comes on November 3

Crude oil will not remain at $40 per barrel forever. The market will either get back on the staircase and make a higher high above $44.05 on November futures, or an event will trigger another elevator shaft journey to the downside. Two issues face the crude oil market over the coming weeks. The first is the November 3 election in the US that could substantially shift energy policy.

The US is the world’s leading crude oil producer. A sweeping victory by Democrats could cause US output to decline. The election is a referendum on the future of the US role in the oil and gas markets.

The other issue is the continuing threat of COVID-19. Futures shutdowns would weigh on energy demand and the price of the energy commodity. Moreover, it tends to be the unknown that causes the most substantial moves. The Middle East remains a part of the world that can trigger significant price volatility. While it seems like ages ago, the rally to $65.65 in January resulted from tensions in the region that is home to over half the world’s oil reserves.

Crude oil has become a tightly coiled spring at the $40 per barrel level. The longer the spring coils, the more dramatic the eventual move. Any risk positions in crude oil require tight stops as we could see volatility return to the market in a blink of an eye.

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The United States Oil Fund (USO) rose $0.02 (+0.07%) in premarket trading Tuesday. Year-to-date, USO has declined -72.09%, versus a 8.25% 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 #68 of 113 ETFs in the Commodity ETFs category.

About the Author: Andrew Hecht

andrew-hechtAndy spent nearly 35 years on Wall Street and is a sought-after commodity and futures trader, an options expert and analyst. In addition to working with StockNews, he is a top ranked author on Seeking Alpha. Learn more about Andy’s background, along with links to his most recent articles. More…

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