Crude Oil Threatens To Keep The Rebound Going - OIH Is One ETF That Remains Cheap
20.01.2019 (seekingalpha.com) –
Summary
- · Christmas Eve was a blow-off low.
- · The weekly chart looks bullish - OPEC cuts are hitting the market.
- · Spreads are tightening.
- · The February-March roll could lead to buying - OIH is still cheap.
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On Friday, January 18, the price of crude oil traded to a new short-term high at over the $54 per barrel level on the nearby NYMEX February futures contract. The price path of the energy commodity has been a wild ride since finding a peak of $76.90 per barrel on October 3. The final three months of last year was a great time for consumers, but a nightmare for producers and investors in the energy commodity as the price dropped like a stone.
As oil was on its way to its peak, US President Trump took to Twitter to put pressure on Saudi Arabia and allies within OPEC to increase their output to control the price rise in the lead up to the November sanctions on the theocracy in Iran. Meanwhile, an international scandal surrounding the murder of a Saudi national and Washington Post journalist in Turkey likely caused Saudi Arabia to capitulate to US demands and pump up the volume of their sales.
At the same time, production in the US rose to 11.7 million barrels per day, and President Trump issued exemptions to sanctions on Iran for eight countries which all contributed to the downward move in the price of the energy commodity. Moreover, many market participants held long positions in the oil market. As they headed for an exit, it exacerbated the price decline. The bearish sentiment in crude oil took hold of the market, and even a production cut of 1.2 million barrels per day at the December OPEC meeting could not stem the price fall. On Christmas Eve, the price of NYMEX futures fell to their lowest level since June 2017.
Crude oil has rallied by over $12 from the lows on a day where liquidity was not at its highest level. At the same time, weakness in the stock market created what was an almost perfect bearish storm for the prices of many oil-related equities. The VanEck Vectors Oil Services ETF product (OIH) declined to a low at $13.13 on December 26 which was the lowest price in two decades.
Christmas Eve was a blow-off low
The price action on December 24 continues to stick out like a sore thumb on the daily chart of February NYMEX crude oil futures.
The chart shows that the Christmas Eve low in nearby crude oil futures took the price to a low at $42.36 per barrel on volume of 626,051 contracts. The number of contracts that traded on December 26 was around half the normal volume which means the price drop occurred during an illiquid pre-holiday trading session. The price action meets many of the requirements for a blow-off low in the oil market. The reversal and recovery that followed Christmas Eve serve to validate that when the price fell to just 31 cents above its critical technical support level at the June 2017 low, the market exhausted its selling.
The weekly chart looks bullish - OPEC cuts are hitting the market
The February NYMEX futures contract has been rolling to March, and the weekly chart has turned decidedly bullish in the oil market.
As the weekly chart highlights, price momentum crossed to the upside and the relative strength indicator turned higher at the end of December when the downside price trajectory came to an end. Open interest, the total number of open long and short positions in the NYMEX crude oil futures market dropped steadily during the price decline and has leveled off so far in 2019. Falling open interest and falling price is not typically the sign of a sustained bearish trend in a futures market. Meanwhile, weekly historical volatility has increased to over 47% as daily trading ranges in the energy commodity have increased since the December 24 low. The metric moved higher from 33.72% during the week of Christmas Eve.
he price of crude oil has posted a gain over the past three consecutive weeks.
On the fundamental side of the market, while US production remains at a record level, the 1.2 million barrel per day output cut by OPEC will now be filtering through the market. In a sign that the cartel's cuts are impacting the supply side of the fundamental equation for crude oil, the Brent premium over WTI on March futures as of last Friday was at the $8.70 per barrel level. Brent crude oil which probed below the $50 per barrel on December 26 was trading above $62.50 last Friday.
Spreads are tightening
The differential between crude oil prices for different delivery dates can serve as a real-time indicator of supply and demand for the energy commodity. When nearby prices are higher than deferred prices, a condition of backwardation exists and is a sign of the market's concern that nearby demand is greater than nearby supplies. When the nearby prices are lower than deferred prices, it is often a sign of supply and demand equilibrium or a condition of oversupply in the crude oil market.
When the spread between the nearby and deferred prices of crude oil are tightening and moving towards a narrower contango or wider backwardation, it tends to be supportive of the price of crude oil.
As the chart of the price of March 2020 minus March 2019 NYMEX crude oil futures shows, the contango narrowed from a high at $3.42 per barrel in mid-to-late December to the $1.37 per barrel level as of last Friday. Meanwhile, the March 2020-March 2019 Brent spread was trading at almost flat after falling from a higher contango over the past weeks. The Brent spread is tighter than the WTI spread because of lower OPEC production and record high US shale output. However, the tightening of the spreads is one sign that the path of least resistance for crude oil remains higher.
The market seems to be concerned that the US will soon end the exemptions to sanctions issued to eight countries that purchase crude oil from Iran. The exemptions were one of the factors that sent the price lower in October through December and a change in policy would likely cause additional buying in the crude oil market over the coming weeks.
The February-March roll - OIH is still cheap
As market participants roll their risk positions on the long and short side from one active month to the next, it can distort prices at times. The differential between February and March NYMEX futures was at the 25 cents contango level as of last Friday which means that March was trading at a 25 cents per barrel premium to the expiring February futures. Open interest at 2.077 million contracts is not at a level that is an extension on the up or downside which is a sign that the speculative interest in the oil market is not at an extreme level.
Crude oil suffered a major blow when the price of NYMEX futures fell from $76.90 to $42.36 over three months. However, the price seems to have found a bottom, and it is likely to build on the recent gains.
Meanwhile, the volatility in the stock market decimated oil-related equities which in some cased fell to their lowest levels in decades at the end of 2018. The oil services sector was hit particularly hard by the bear market run in oil and stocks.
The VanEck Vectors Oil Services ETF product holds a portfolio of some of the biggest names in oil services. The most recent positions include:
The market action crushed the price of these companies and the OIH at the end of last year.
As the chart shows, OIH fell from $26.33 in October 2018 to a low at $13.13 in late December when oil hit its bottom. The lows in the OIH ETF were the lowest level on the chart dating back to 2001. Last Friday, the ETF was trading at the $17.12 level. OIH pays a 2.75% dividend and trades an average of over ten million shares each day. With a market cap of 1.04 billion, it is a highly liquid ETF product.
Crude oil fell to a blow-off low and came within 31 cents of its June 2017 low. It now looks like a recovery is likely to continue in the crude oil market which has made higher highs so far in 2019. Oil services stocks fell to a two-decade low and a level that was screaming that the selling in December was overdone and the current price at just over the $17 per share level continues to offer tremendous value. I am bullish on the prospects for the OIH ETF product even though it has moved $4 higher from its late December low as it remains cheap.
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