Confused about where crude oil prices are headed lately? Trust me, you aren’t alone.
The most recent decline in oil prices began in June 2014 and experienced a drop of approximately 55% in over 190 days.
The price, based on West Texas Intermediate (WTI), has yet to recover even 50% of its loss!
And for the past two months, the price has been hovering around $60 per barrel.
Now, two belief camps have developed. One expects WTI prices to break $50 per barrel on the downside. The other expects $75 or even $100 in the not-too-distant future.
These two camps are locked in a tense struggle over who will be right. But that doesn’t matter, because you can profit either way…
Been There, Done That
The kind of price drop we saw last year has occurred throughout this liquid commodity’s recent history. It’s really to be expected at this point.
Just look at the swings in oil prices we’ve seen over the last three decades. Plus, the seemingly random amount of time it took for prices to recover 50% of their loss from the low.
In all cases, crude oil prices did recover. But there was no consistency in terms of how long it took.
During each episode, the global markets had their own unique and idiosyncratic characteristics to contend with amid vastly different crude supply and demand attributes. Certain price drops were supply driven, while others were demand driven. And, in some cases, it was a bit of both.
The Third Choice
Lately, a third camp has formed that believes in a different outcome from the original two.
The spectators in this tug of war, including economists and portfolio managers, are predicting that the price of WTI will hover around $60 for the next few years.
The basis for their beliefs comes from the current policy-making climate.
You see, President Obama’s views are practically the polar opposite of those held by the Republican administration on a number of energy issues, such as an extension of the Keystone XL pipeline, the acceleration of U.S. crude oil exports, the level of controls by the Environmental Protection Agency, and the opening of additional public land for oil and gas production.
As we’ve seen, essentially nothing has gotten passed.
Plus, Fed Chairman Janet Yellen is still in wait-and-see mode as far as interest rates go, while the U.S. dollar is stuck in a narrow trading range.
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Meanwhile, business consultancy IHS released a study showing that 80% of the tight oil (largely from fracking) estimated to be produced in 2015 will still be profitable for U.S. oil producers between $50 and $70 per barrel.
It’s a real mixed bag when it comes to the effects Europe will have.
Greece needs to come up with €1.2 million by the end of the month, or else talks of kicking them out of the European Union are likely to resume. And on the upside, nations such as Spain are seeing signs of economic improvement.
The outlook on emerging markets also varies by country.
China is truly slowing. But others are in stimulus mode in an effort to boost their respective economies.
And finally, the Organization of Petroleum Exporting Countries (OPEC) decided during its June 5 meeting in Vienna to maintain the 30 million barrels per day ceiling and urged its member countries to adhere to it.
No Need to Waffle
This situation could go in so many directions. But the market can only go up or down.
So rather than drive yourself crazy over which camp will win out in this brutal tug of war, profit from the uncertainty instead. Just follow the old buy low, sell high rule.
Until one camp finally wins – which may take some time – chose a level below $60 to buy and a level of the same distance above $60 to sell. This level could be as small at $0.75 per barrel.
Just look at how many times the price of WTI has closed above and below $60 since the beginning of May!
If you find yourself siding with one camp over the other, then you can add to your position.
For example, if you’re bullish, you can enter into a bull spread by selling a near-term crude oil contract, (six months out) and buying one further out (18 months), or do the opposite if you’re bearish.
A similar bullish strategy can be accomplished using call options.
Because long-dated options are more expensive than short-dated options, as you’re paying the additional time value, you can trade a ratio option such as a two for one – selling two nearby calls and buying one call further out.
Do the reverse if you’re bearish, or, alternatively, trade puts.
Look for opportunities when prices and volatility are to your favor and keep a steady eye on the forward curve, which is currently in a contango, albeit not steeply.