The Potential for an Explosive Move in Crude Oil

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January 14, 2020 12:34pm NYSE:USO

NYSE:USO | News, Ratings, and Charts

  • The price rises on the back of Iran and then falls on an immediate de-escalation
  • Open interest moves higher with the price- A bullish sign
  • Fasten your seatbelts as oil will move with tensions in the Middle East


We are only around two weeks into 2020, but the crude oil market has been highly volatile as the temperature rose and fell in the most turbulent political region on the face of the earth. The Middle East is home to over half the world’s crude oil reserves, but the supply balance changed dramatically over the past years. In the 1980s or 1990s, the recent events may have caused the price of crude oil to double and then to halve over short periods. These days, the moves are tame, by comparison.

In 1990, when Saddam Hussein marched into Kuwait, the price of crude oil moved from $20 to $40 per barrel in what seemed like the blink of an eye. These days, US production at 12.9 million barrels per day is higher than the second two leading producers of the energy commodity; Saudi Arabia and Russia. Therefore, problems in the Middle East do not have the same impact on oil prices they did just a few short decades ago.

While the oil markets calmed last week, we could see a continuation of volatility over the coming weeks and months. The United States Oil Fund (USO) and the United States Brent Oil Fund (BNO) track the prices of the two global oil benchmark prices.

The price rises on the back of Iran and then falls on an immediate de-escalation

There was lots of action in the crude oil futures arena last week. The price rose to a high of $65.65 per barrel on January 8, which was only 95 cents below the 2019 peak. Nearby crude oil futures then fell to a low of $58.66 the next day, and settled at $59.04 per barrel on Friday, January 10. Crude oil put in a bearish reversal trading pattern on the daily chart on January 8.

(Source: CQG)

The daily chart highlights that the price rose to a higher level than the previous day, and then proceeded to close below the prior day’s low.  

(Source: CQG)

The weekly chart illustrates that the energy commodity put in the same bearish technical pattern on a weekly basis. A bearish reversal tends to lead to lower prices in the oil market that often takes the stairs higher and an elevator to the downside. However, the situation in the Middle East will continue to dictate the path of least resistance for prices.


Open interest moves higher with the price- A bullish sign

Open interest is a metric that measures the total number of open long and short positions in a futures market.

(Source: CQG)

The daily chart shows that the price of February NYMEX crude oil futures rose from $50.44 on October 3 to a high of $65.65 on January 8 or 30.2%. Over the same period, open interest moved from 2,132,422 to 2,222,854 contracts or 4.24%. Rising open interest and increasing price tend to be a validation of a bullish trend in a futures market. The open interest metric was at 2,225,737 contracts at the end of last week.

Technical metrics can provide guidance when it comes to price direction. However, the news cycle and Iran’s behavior over the coming days and weeks will push crude oil futures higher or lower.

The US killed the commander of Iran’s revolutionary guard, which led to a retaliatory missile attack on Iraqi airbases that house US troops. Oil hit the high during the missile attack. Fortunately, there were no casualties. US President Trump did not retaliate with any military action. Tragically, Iran fired a missile that took down a commercial airliner. All passengers and crew perished as the plane crashed shortly after takeoff.


Fasten your seatbelts as oil will move with tensions in the Middle East

The Iranian economy continues to suffer under the weight of US sanctions. In the aftermath of the missile attack, President Trump said Iran would never have a nuclear weapon on his watch and that sanctions would increase. He asked NATO to join with the US to work on a new agreement with the theocracy in Teheran.

Iran said they would continue to enrich uranium. While some diplomatic signals were that they would not fire more missiles, the rhetoric out of the military continued to call for attacks at the end of last week. The downing of the passenger aircraft could cause NATO members to take a harder line against Iran over the coming weeks.

Iran and the US have not been as close to an outright war since the 1979 hostage crisis. Iran and Saudi Arabia continue to fight proxy wars in the Middle East. Israel will not allow Iran to develop any nuclear weapons. The leadership of Iran continues to chant death to American and death to Israel. Despite the de-escalation by the end of last week, the situation remains fluid and dangerous.

Any hostilities that impact production, refining, or logistical routes like the Straits of Hormuz or others in the region, would likely cause a spike in the price of crude oil. Around 20% of the world’s daily oil supplies travel through the Straits. A prolonged conflict could cause a supply shock that sends the price of oil appreciably higher.

Crude oil tends to take the stairs higher and an elevator down, but in the current environment, the elevator could travel in both directions in the blink of an eye.

The United States Oil Fund LP (USO) was trading at $12.27 per share on Tuesday afternoon, up $0.07 (+0.57%). Year-to-date, USO has gained 2.16%, versus a 23.41% rise in the benchmark S&P 500 index during the same period.

USO currently has an ETF Daily News SMART Grade of A (Strong Buy), and is ranked #1 of 109 ETFs in the Commodity ETFs category.

About the Author: Andrew Hecht

andrew-hechtAndrew Hecht is a sought-after commodity and futures trader, an options expert and analyst. He is a top ranked author on Seeking Alpha in various categories. Andy spent nearly 35 years on Wall Street, including two decades on the trading desk of Phillip Brothers, which became Salomon Brothers and ultimately part of Citigroup. Over the past decades, he has researched, structured and executed some of the largest trades ever made, involving massive quantities of precious metals and bulk commodities. Aside from contributing to a variety of sites, Andy is the Editor-in-Chief at Option Hotline.

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