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Oil Correction: An Opportunity For 2022

By Andy HechtCommoditiesDec 03, 2021 22:14
Oil Correction: An Opportunity For 2022
By Andy Hecht   |  Dec 03, 2021 22:14
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  • The stairs higher and an elevator lower
  • The crude oil trend remains higher - Higher lows on the horizon
  • US energy policy supports higher crude oil prices - Seasonality is weighing on prices
  • US inventories and production are fundamentally bullish - OPEC+ will determine the oil price - US SPR sale, history suggests it doesn’t matter
  • Buying the dip over the coming weeks

Addressing climate change will take decades. The world continues to rely on fossil fuels for power. Over the past months hydrocarbon prices have risen to multi-year highs. Coal exploded to prices higher than in 2008. Natural gas moved to its highest level since February 2014. The nearby January NYMEX natural gas futures contract peaked at $6.667 per MMBtu, a level not seen since 2008. Crude oil moved to its highest level since 2014, the latest time the energy commodity traded at over $100 per barrel.

Crude oil tends to crawl higher, reach an unsustainable level, and experience a sharp decline. After the nearby NYMEX futures contract rose to $85.41 on Oct. 25, the price corrected, falling to a low of $64.43 per barrel on Nov. 30. The 24.6% decline comes during a seasonally weak time of the year. Natural gas did even worse, falling to $4.22 on Dec. 1, a 36.7% plunge.

While the correction could take the price even lower, all signs point to higher prices in 2022. Buying crude oil on price weakness over the coming weeks could be the optimal approach for the coming year.  

The stairs higher and an elevator lower

Friday, Nov. 26, was an ugly day in the oil futures market. The selling continued to take the price lower this week. A correction was overdue after the energy commodity ran out of upside steam at $85.41 per barrel on the continuous futures contract in late October. NYMEX crude oil futures reached the highest price since 2014, the last time the energy commodity traded above the $100 per barrel level. 

Crude Daily
Crude Daily

Source: CQG

The daily chart of January NYMEX crude oil futures shows the energy commodity fell off the side of a bearish cliff on the session after the Thanksgiving holiday. News of a new COVID-19 variant triggered selling that caused a nearly 25% decline, the most substantial drop since April 2020 when crude oil briefly moved under zero.

The January futures price reached a low of $64.54 per barrel and was still under pressure on Wednesday, Dec. 1. Crude oil took an elevator shaft to the downside. 

The crude oil trend remains higher; Higher lows on the horizon

While the decline starting on Nov. 26 was hair raising, it has yet to negate the bullish price trend that has been in place since the April 2020 low.

Crude Weekly
Crude Weekly

Source: CQG

As the weekly chart highlights, the price carnage at the end of last week did not negate the bullish trend. The first technical support level stands at $61.74 per barrel, the late August 2021 low. A move below the August 2021 bottom would harm the crude oil market’s trend, but the odds favor that the level will hold. We may have already seen the low on Nov. 30. 

US energy policy supports higher crude oil prices; Seasonality is weighing on prices

On his first day in office, US President Joseph Biden canceled the Keystone XL pipeline project. In May, the administration banned drilling and fracking for oil and gas on federal lands in Alaska. Addressing climate change has been the administration’s central focus as it moved to replace fossil fuels with alternative renewable energy sources.

Meanwhile, crude oil continues to power the world. Over the past weeks, the administration twice requested OPEC+ to increase output. The cartel and Russia refused. President Biden signed an executive order releasing fifty million barrels of crude oil from the US strategic petroleum reserve to temper prices.

Gasoline, the most ubiquitous oil product, tends to experience demand declines during the winter months as drivers put less mileage on their cars. The winter can be a seasonally weak period for crude oil. The latest selloff came on the back of fears that another virus mutation would cause travel restrictions and less demand for the energy commodity. Seasonality only exacerbated the selling.

US inventories and production are fundamentally bullish; OPEC+ will determine the oil price; US SPR sale, history suggests it doesn’t matter

Over the past months, robust energy demand lifted crude oil’s price, pushing it to a seven-year high before the latest correction. However, fundamental data continues to support the energy commodity. In March 2020, daily US output reached an all-time high at 13.1 million barrels per day. The Energy Information Administration reported that daily production stood at the 11.6 mbpd level as of Nov. 26, 11.5% lower than at the high.

Oil companies are not investing in new US production as the administration has put up roadblocks for fossil fuel production, supporting renewable energy. It will take decades to replace oil and gas with wind, solar, and other power sources. Around one percent of US cars are EVs, which means gasoline demand will remain robust as the economy improves. Moreover, rising inflation only exacerbated price increases over the past months. 

While the administration is releasing petroleum from the SPR, data from the American Petroleum Institute shows declines in crude oil and oil product stockpiles so far in 2021.

The decline in US output under the Biden administration handed the petroleum market pricing power back to OPEC+. After years of suffering from low prices because of US shale output, pricing decisions in Moscow and Riyadh will not determine the energy commodity’s price for consumers worldwide. The cartel would rather sell one barrel at $100 than two at $40.

While the President released fifty million crude oil barrels from the SPR in November, it only amounts to three days of US consumption. Past SPR sales did little to impact price trends in the oil market.

Buying the dip over the coming weeks

Markets tend to move higher or lower than most analysts believe possible when they begin to move. It is virtually impossible to pick tops or bottoms in any asset, and crude oil is no example. In April 2020, we learned that events could take the oil price to a level that defies logic, reason, and rational fundamental analysis.

It is possible that crude oil can move below $60 by the end of 2021, but that would create a compelling buying opportunity for 2022.

The bottom line is the US is far less of a factor in the crude oil production arena than in past years. Moreover, rising demand will make the US more dependent on foreign petroleum in 2022. US energy policy, OPEC+’s control of production policy, rising inflation, and economic growth create a potent bullish cocktail for the oil market.

I do not believe we have seen the highs in crude oil and expect the price to rise to over the $100 per barrel level in 2022. The current selloff could be the perfect time to load up on the energy commodity but keep the buying scales wide as short-term selling can be nasty, as we experienced on Nov. 26.

OPEC+ has made it clear it has no intentions to help the US or other consumers worldwide. The cartel will use every opportunity to push the price back above the $80 per barrel level and higher in the coming months. Given the supply and demand landscapes, they may not have to do all that much.

Oil Correction: An Opportunity For 2022

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Oil Correction: An Opportunity For 2022

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