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Crude Oil: Making Sense of the 3-Year High

Lots of factors to consider, from technicals to supply and demand

by Editorial Staff
Updated: April 19, 2018

Screen Text:  What stands out for you short term in the Energy markets?

Steve Craig:  The new 2018 high and the potential for greater market volatility. The new rebound high implies that the advance from the 26.05 low in 2016 hasn't run its course. The geopolitical tensions are mounting, which increases the headline risk and the potential for greater market volatility. Currently, Syria is front and center with the second US missile strike. This further phrased the strained relations between Russia and the US and most of its NATO allies. Looking ahead, there's a potential for the US to withdraw from the Iranian nuclear deal. There's denuclearization talks with North Korea, and trade tariffs are still an issue. So the potential for more headline risk certainly exists.

Screen Text:  Rig counts continue to inch higher… are they chasing demand or leading it?

SC:  Well, at its core, drilling is an economic decision. Assuming that money isn't an issue, what are the odds of finding and completing an economically viable well? Well, there's a lot of work that goes into it. But if it's determined that there's a high likelihood of drilling success, the decision to deploy the necessary capital boils down to the potential to recoup the investment and generate a profit. Now I can't speak to how any one company makes the determination. But the best measure of potential financial success is a favorable forward price curve. In other words, if drilling results in a producing well, the company has the option of using the financial markets to hedge or lock in an expected rate of return. So while it may appear that companies are chasing demand, they're really chasing price. And that's evident in the lag time between the number of active drilling rigs and the price of oil at major turning points.

Screen Text:  The IEA suggested last week that the global oil market is almost drained of excess crude given the decline in inventories. Do headlines like this suggest anything to you?

SC:  It's just the IEA, the International Energy Agency, not to be confused with the EIA, the Energy Information Administration at the US Department of Energy, doing what it does as far as measuring the global supply-demand balance. From an Elliottician's perspective, changes in supply and demand are meaningless. Journalists may cite a change as a causative factor for what has already transpired with respect to price, but it works the other way around. Changes in supply and demand are much better explained by changes in price. This is clearly evident at market extremes. Fundamentals always look the rosiest at the top and the bleakest at the bottom. This gets back to the herding instinct-- The Socionomic Theory of Finance.

Screen Text:  Turning to crude prices… further upside?

SC:  The strength at the end of March led me to believe that a top wasn't in place. The rally should carry prices higher yet. From a big picture perspective, nothing has changed. The advance from the 26.05 low in 2016 should prove corrective and set the stage for a substantial decline.

Screen Text:  And yet you believe the XLE has significant downside…

SC:  Long term-- yes, it's currently in a corrective advance. From a shorter-term perspective, further strength should set the stage for a substantial decline.

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