Will Oil Prices Gush Higher or Spill Lower?
Fundamentals
The year is off to a rough start for energy bulls, as Crude Oil prices have fallen over $10 per barrel in the past 3 weeks. The main catalysts for Oil's slide have been a rising U.S. Dollar, the Chinese government's attempts to slow down its economy, and the seemingly anti-business rhetoric coming out of Washington. However, there appears to be some bullish news starting to trickle out. Yesterday, the Institute of Supply Management's manufacturing index for January rose to 58.4, vs. 54.9 in December. This was the highest reading in nearly 4 years and is a good indication that the U.S. manufacturing sector is starting to recover, which is essential for Oil demand to improve. Also supportive were reports out of Nigeria that a pipeline operated by Royal Dutch Shell was breached by vandals, causing a shutdown of three flow stations to the Forcados export terminals. Nigeria is one of the top 5 oil exporters to the U.S., and any signs of instability there can spark buying interest in Oil. However, Chinese Oil demand remains a wild card this year, as its government's attempts to slow down its surging economy is leading may traders to look for a subdued increase in Oil demand from the world's most populous nation. OPEC members once again have failed to heed their quotas, as it is estimated that compliance was running at only 55% last month, with production rising to yearly highs. Large speculators, who have been net-long Crude Oil futures for months, have started to lighten-up on their positions lately, with the most recent Commitment of Traders report showing large non-commercial traders shedding 39,622 net long positions as of January 26th, leaving this segment net-long 167,130 contracts. Although Oil bulls have lightened-up on their positions during the sell-off, the net-long position is still burdensome -- and if Oil bulls don't get some bullish news soon, major support near 72.40 may yet again be put to a test.
Trading Ideas
Given the mixed fundamentals in the Oil market, one could make a valid argument that oil prices are heading either higher or lower in the near-term. One way to position for a large move in either direction or an increase in volatility could be to purchase a strangle in Crude Oil options. A strangle consists of a call and a put option in the same contract, same trading month, and same strike price. An example of this trade would be buying the March Crude Oil 74.00 strangle. With March Oil trading at 74.00 as of this writing, the 74.00 strangle could be purchased for about 3.84 points, or $3,840 per strangle, not including commissions. The trade will be profitable at expiration if March Crude Oil is trading above $77.84 or below $70.16.
Technicals
Looking at the daily chart for March Crude Oil, we notice strong support just above the 72.40 area. This area has been tested numerous times since mid-December, and Oil bears have not been able to overcome the buying that emerges at this key level. However, to put the bulls back in control, we would need to see a solid close above the 100-day moving average, which is currently near the $77.10 area. The 14-day RSI has emerged from oversold levels, currently reading a still weak 36.61. In addition to the weekly EIA energy stocks report, traders will be eagerly anticipating the release of January non-farm payrolls on Friday, with the consensus looking for payrolls to remain unchanged last month, vs. the 85,000 decline in December. Should the figures come in well off the estimates, the potential for a large move in Oil prices will likely increase. 72.43 remains support for March Oil, with resistance found at 77.10.
Mike Zarembski, Senior Commodity Analyst
