Shifting Dynamics Should Lead to Gains in 2021 for Crude Oil

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December 28, 2020 9:26am NYSE:USO

NYSE:USO | News, Ratings, and Charts
  • Shifting energy dynamics

  • Crude oil is still the king of the energy sector

  • Bullish short-term- Politics will create volatility in 2021

Many markets tend to take the stairs higher and an elevator lower. In the stock market, the reason the VIX index often rallies during corrective periods. The VIX reflects the prices of put and call options on the S&P 500 stocks. Market participants tend to buy options, or price insurance, when the market is falling, forcing the VIX higher. The stock market is one example of this phenomenon, and the world’s most liquid commodity, crude oil, is another.

At the beginning of last week, we witnessed another example of how crude oil takes the elevator to the downside during price corrections. The price had been on the staircase to the upside since reaching a low of $33.64 per barrel on the nearby NYMEX futures contract on November 2. The price moved to a high of over $49 on Friday, December 18.

On December 21, the energy commodity got back on the elevator and fell below the $47 level after January NYMEX futures rolled to February. The winter months tend to be a seasonally weak period for crude oil. As we move into 2021, we should continue to expect volatility in the crude oil futures arena. While the world looks to move away from fossil fuels, petroleum will still provide energy for the coming years.

A shift in dynamics may only exacerbate the price volatility in the coming year. The United States Oil Fund (USO) tracks the NYMEX crude oil futures’ price higher and lower.

Shifting energy dynamics

On January 20, 2021, Joe Biden will become the forty-sixth President of the United States. President-elect Biden pledged to address climate change during the campaign. His administration will rejoin the Paris climate accords. US energy policy will shift from the drill-baby-drill and frack-baby-frack environment under President Trump to a far stricter regulatory atmosphere over the coming years. Progressive Democrats are likely to push the incoming President towards policies that would cause US crude oil and natural gas output to decline. Rising costs and limits or even bans on fracking will cause production to fall.

Over the past years, US crude oil production surpassed Russian and Saudi Arabian output as it rose to a record 13.1 million barrels per day in March 2020. We are likely to see that record stand for a long time given the US energy policy shift under the Biden administration. The extent of the change depends on the upcoming January 5 runoff elections in Georgia that will determine the Senate’s balance of power.

A victory by Democrats would create clear sailing for the incoming President’s initiatives. If Republicans maintain control of the Senate, the administration will need to compromise, limiting the energy policy change. In either case, some of the pricing power in the crude oil market will revert to OPEC+, handing Russia and Saudi Arabia more influence over the future path of petroleum prices. Since the leading producers have a vested interest in higher prices, we should expect them to follow production policies that encourage rising oil prices.

Crude oil is still the king of the energy sector

While the Biden administration will encourage less oil production and consumption, crude oil remains a critical energy source for cars, planes, trucks, ocean vessels, heating, and other requirements that power the US and countries worldwide.

It will take years, if not decades, to shift to alternative energy sources and abandon fossil fuels. China and India, the world’s most populous nations, with over one-third of the world’s people, continue to consume crude oil. A shift in US energy policy will not materially impact the fundamental equation’s demand side in the near-term. Still, it will affect the supply side if production drops significantly.

The US briefly became the crude oil king during the Trump administration, but the crown looks likely to pass to Russia and Saudi Arabia, given the shift in energy policy under the incoming administration. As the global population continues to rise, the energy demand will move higher. We could see higher oil prices over the coming years, and crude oil is heading into 2021 in a bullish trend.

Bullish short-term- Politics will create volatility in 2021

The move to a negative price for crude oil in late April was an outlier, created by the global pandemic.

Source: CQG

Since then, we have seen the oil futures market make higher lows and higher highs. The most recent peak came on December 18 when the nearby February NYMEX futures contract reached a high of $49.43 per barrel. The February Brent contract reached a peak of $52.47.

Crude oil tends to take the stairs higher and an elevator lower. Another elevator ride is always possible, but the trend remained higher as of December 24.

The crude oil futures market put in a bullish reversal on the monthly chart in November. The price traded below the October low and closed November above the previous month’s high.

Source: CQG

A close above $43.78 on the nearby NYMEX futures contract on December 31 would create a bullish reversal on the quarterly chart going into 2021. Expect lots of volatility in the oil market during the coming year. A shift in US energy policy, a falling dollar, and rising inflation because of monetary and fiscal policies could turn out to be a potent bullish cocktail for the energy commodity that continues to power the world for the coming year. Brewing tensions with Iran is another factor that could lift the price of the energy commodity in 2021 just as it did in early 2020.

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The United States Oil Fund (USO) rose $0.18 (+0.55%) in premarket trading Monday. Year-to-date, USO has declined -67.80%, versus a 17.67% 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 #69 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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