Exciting 2021 On The Horizon for Crude Oil

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January 4, 2021 10:15am NYSE:USO

NYSE:USO | News, Ratings, and Charts
  • An over $100 trading range in nearby NYMEX futures in 2020

  • Lots of price action ahead in 2021

  • The US and global politics could light a bullish fuse

  • The financial landscape is bullish for crude oil, but it could be another wild ride

2020 was anything but a dull year in the crude oil markets. The year began with prices reaching the peak in early January when the US and Iran faced off in Iraq after the killing of a high-profile Iranian military commander. Energy demand evaporated as the global pandemic closed down broad parts of the worldwide economy in February through April, sending the price of NYMEX crude oil futures into negative territory for the first time in history. Brent futures fell to the lowest level of this century.

Like the stock market, crude oil tends to take the stairs higher and an elevator shaft to the downside during corrections and bear markets. The price of nearby WTI NYMEX and Brent ICE futures are heading into 2021 on either side of $50 per barrel. While the price range in 2020 will be a challenge to replicate, the energy commodity is likely to experience lots of volatility in 2021.

The United States Crude Oil Fund (USO) replicates the price action of a portfolio of NYMEX WTI futures. The United States Brent Crude Oil Fund (BNO) tracks the price action in a portfolio of ICE Brent futures.

An over $100 trading range in nearby NYMEX futures in 2020

The crude oil futures market mirrored the pulse of markets in 2020. During the first week of trading in January 2020, the price of nearby NYMEX futures rose to the highs of 2020 at $65.65. The faceoff between the US and Iran in Iraq after the killing of a top Iranian military commander ignited supply concerns that sent the price of crude oil to a peak. As the confrontation did not accelerate, the price settled back, causing crude oil to make lower highs and lower highs through mid-February when the bottom fell out of the market. On April 20, a crescendo of selling sent the energy commodity below zero and a record low.

Source: CQG

The weekly chart highlights the $105.97 trading range in NYMEX WTI crude oil futures in 2020. The energy commodity fell to a low of negative $40.32 per barrel on April 20. WTI is a landlocked crude oil with a delivery location at a pipeline in Cushing, Oklahoma. At the beginning of the global pandemic, demand evaporation caused those holding long positions in the expiring May futures contract with no options to store the energy commodity. Therefore, the nearby contract became a bearish hot potato with longs selling at any price as taking delivery was not possible. Margin calls as the price dropped caused force liquidations of futures positions.

Since the low, crude oil has taken the stairs higher, with a few speedbumps along the way. The price settled at the $48.52 per barrel level on December 31, 2020, $88.84 above the year’s low and $17.13 under the 2020 peak.

As we head into 2021, the total number of open long and short positions in the NYMEX futures arena was at the 2.155 million contract level. At the end of 2019, the metric was only a little lower at 2.146 million.

Weekly price momentum and relative strength indicators were well over neutral readings with momentum in overbought territory. The metrics were in the same position as at the end of 2019 on the final trading session of 2020. Weekly historical volatility at 37.8% on December 31, 2020, was higher than at the end of the previous year when it was around the 20% level.

Lots of price action ahead in 2021

Like many commodities, crude oil tends to take the stairs higher and an elevator shaft lower during bear market corrections. Rallies can take months; violent corrections often occur in the blink of an eye, as we witnessed in Aril 2020. We are moving into 2021 on a staircase higher threatening to challenge the $50 level on the nearby NYMEX futures contract.

In 2020, the unforeseen event, a global pandemic, caused the demand to evaporate, leading to the most substantial price volatility in history for the energy commodity. Any significant moves in 2021 will likely come from an event that hits the market out of the blue. The unknown always tends to ignite the most substantial price variance in crude oil and markets across all asset classes.

Meanwhile, the landscape of “knowns” going into 2021 is mostly bullish for the price of the energy commodity.

The US and global politics could light a bullish fuse

Politics in the US and worldwide look to be a supportive factor for the oil market in the new year. In the US, the incoming Biden administration has pledged to increase alternative and renewable energy sources and decrease fossil fuel output.

The January 5 runoff Senate elections will determine the Senate’s balance of power and the extent of the US energy policy shift. However, the Biden administration will rejoin the Paris climate accord, increase regulations on energy producers, limit fracking and other extraction techniques, and push production costs higher. US crude oil output reached a record 13.1 million barrels per day in March 2020.

The upcoming shift in energy policy will cause production to decline. The March 2020 peak in output will stand as a record for the foreseeable future. OPEC+ will continue to taper their production cuts as the worldwide economy improves. However, the decline in US output will cause the cartel to do its utmost to achieve the highest price for its members. A move away from hydrocarbon production in the US will hand pricing power back to OPEC, the cartel controlled by Russia and Saudi Arabia.

While the Biden administration will support moves to reestablish the Iran nuclear nonproliferation agreements, it could be a goal that is too far to reach. The assassination of Iran’s top nuclear scientist has increased tensions.

Moreover, the recent warming of relations between Israel and many Arab nations is an affront to the Iranian theocracy. Iran and Saudi Arabia remain mortal enemies. Any hostilities that impact production, refining, or logistical routes in the Middle East could cause sudden rallies. While crude oil tends to take the elevator to the downside, events that threaten Middle East supplies can drive the elevator to move higher. The Middle East remains home to more than half the world’s crude oil supplies.

The US and geopolitical landscape for crude oil are mostly bullish going into 2021.

The financial landscape is bullish for crude oil, but it could be another wild ride

There may be nothing more bullish for all commodity prices than the financial landscape going into the new year. If the period from 2008 through 2011 is a model for 2020 and the coming years, explosive rallies in commodity markets could be on the horizon. Following the 2008 global financial crisis, central banks and governments unleashed unprecedented liquidity, pushed interest rates to historic lows, and stimulated economies via bailouts and other fiscal policy tools.

While the 2020 pandemic was a far different crisis than in 2008, the central banks and governments used the same tools to encourage spending and borrowing and inhibit saving. The only difference is that the amount of monetary and fiscal stimulus in 2020 was far higher than in 2008. As an example, the US Treasury borrowed a record $530 trillion from June through September 2008. In May 2020, it borrowed $3 trillion. The latest stimulus program promises more borrowing in 2021.

The price tag for the tidal wave of liquidity and tsunami of stimulus is inflation. The increase in deficits and the money supply is fertile ground for inflationary pressures, which push commodity prices higher. After the 2008 financial crisis, commodity prices rose to multi-year or all-time highs by 2011 and 2012. With the level of monetary and fiscal programs higher in 2020, why should we expect any different market response over the coming years?

Many signs point higher for the crude oil market in 2021. However, as we have learned over the past years, the unknown can move the price the most. Bull markets rarely move in a straight line. I would be a buyer of crude oil on price weakness but will have my eyes open for those unexpected events that can change the landscape for the path of least resistance of prices. If 2020 taught us anything, it is always to expect the unexpected in markets.

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The United States Oil Fund (USO) was trading at $33.25 per share on Monday morning, up $0.24 (+0.73%). Year-to-date, USO has gained 0.73%, versus a 0.11% 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 #70 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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