Three Headwinds to Send Crude Oil Into Free Fall
Not too long ago, Gasoline prices rattled American car drivers with a price tag of USD 5 a gallon. And now, much to their delight, gasoline prices have eased to USD 3.50 a gallon.
Slump in crude prices which influences gasoline has plunged by one-third over the last twelve months. A barrel of West Texas Intermediate ("WTI") trades around USD 70.
Rattled US consumers, underwhelming Chinese recovery, and robust supply will drag crude oil prices down even further in the near term at least until OPEC+ meeting on June 4th. Barring an OPEC+ “shock-and-awe” intervention, crude oil will continue losing steam.
This paper argues that a short position in CME Micro WTI Crude Oil expiring in July (MCLN2023) with an entry of USD 71.90 a barrel with a target of 64.80, and hedged by a stop loss at 75.60, is likely to yield a reward-to-risk ratio of 1.9x.
RATTLED BUT RESILIENT. US CONSUMER SENTIMENT IS WEAKENING.
Oil prices face massive headwinds in the near term in line with frail U.S. consumer sentiment. It slumped to a six-month low as a debt ceiling drama fuelled worries about the economic outlook.
The University of Michigan's preliminary reading of consumer sentiment index clocked 57.7 pointing to the lowest reading since last November and down from 63.5 in April.
Consumer sentiment tumbled 9% wiping out over half of the gains achieved after the all-time historic low from last June.
While current macroeconomic data show little sign of recession, consumers’ worry about the economy escalated this month.
Expectations for the economy a year from now sank 23% from last month. Longer term expectations contracted 16% highlighting that consumers concerns that economic downturn will not be shortlived.
Consumers have demonstrated resilience thus far. But their anticipation of a recession will trigger to cut spending when signs of weakness emerge.
An unresolved banking crisis and a prolonging debt ceiling drama paint a dismal picture for US consumers. It will amplify if debt default drama continues this week with rising likelihood of default and the resulting economic consequences.
UNDERWHELMING CHINESE RECOVERY
The much-anticipated economic rebound never occurred, but to describe it as underwhelming might be an understatement.
Broad economic indicators point to weakening instead of recovery. Industrial production and retail sales missed forecasts. Unemployment rate among youth set a record high of 20.4%.
A frail global economy adds to China’s gloom. High inflation and elevated rates in China’s key destination countries have slashed demand for Chinese products. Exporters at China’s largest trade fair reported a drop in overseas orders.
Infrastructure and manufacturing investment, which have helped to offset the slump in property investment, both slowed in April from the previous month, a sign of more subdued government spending and weak business confidence.
The property market remains weak despite early signs of a pickup in housing sales. Consumers are reluctant to borrow. China’s home price growth slowed in April. Indicators show slowing momentum in home purchases despite Government’s effort to prop up the real estate. China’s housing starts is at its lowest when compared over the last 10 years.
Property investment shrank more than 16% in April YoY even though home sales grew. Construction of new homes continued to decline.
New household loans, posted the first decline in 12 months in April 2023, suggesting that residents repaid more than they borrowed.
NOT WEAK DEMAND BUT UNSEEN ROBUST OIL SUPPLY
More than Expected Supply
Given the gloomy headlines, it is easy to fall prey to the notion that demand is the problem. The real problem is too much supply, argues Javier Blas of Bloomberg.
Unexpected production is primarily coming from OPEC+ countries despite promise of supply cuts. Many oil producing nations are unknowingly participants of the prisoner's game.
Demand Remains Steady
The IEA raised its forecast for 2023 global oil demand by 400,000 bpd, setting a record daily consumption of 102 million barrels. In short, demand remains resilient.
IEA’s optimism may be misplaced, and oil demand growth might soften. But its forecast accounts for pessimistic diesel outlook.
Presently, the oil market has all its eyes on Washington. The US gulps two out of every ten barrels pumped worldwide. But America is not the oil market. Its consumption lead has narrowed significantly. In 2023, the combined consumption of China and India (21.4 million bpd) is expected to be larger than the US (20.3 million bpd).
The real hurdle holding back an oil rally is supply. The need for cash in producing nations forces them to pump more. These countries are trying to make up for lost revenues by ramping up volumes to compensate for what they are losing due to lower prices.
MANAGED MONEY ARE BEARISH AT LEVELS UNSEEN SINCE 2011
Net position of non-commercial players is at its most bearish levels since 2011 across a combination of major oil contracts.
Non-commercial participants include hedge funds, proprietary trading groups, asset managers, among others. Other Reportable Positions represent open interest by large participants that trade their own accounts and do not fit into any other category.
TRADE SETUP
Amid gloomy outlook and strong headwinds, this paper posits that a short position in CME Micro WTI Crude Oil Futures expiring in July (MCLN2023) with an entry of USD 72.00 with a target of 64.80, and hedged by a stop at 75.60, is likely to deliver a reward-to-risk ratio of 1.9x.
• Entry: 71.90 USD/barrel
• Target: 64.80 USD/barrel
• Stop: 75.60 USD/barrel
• Profit at Target: USD 710
• Loss at Stop: USD 370
• Reward-to-risk: 1.9x
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme/.
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
Slump in crude prices which influences gasoline has plunged by one-third over the last twelve months. A barrel of West Texas Intermediate ("WTI") trades around USD 70.
Rattled US consumers, underwhelming Chinese recovery, and robust supply will drag crude oil prices down even further in the near term at least until OPEC+ meeting on June 4th. Barring an OPEC+ “shock-and-awe” intervention, crude oil will continue losing steam.
This paper argues that a short position in CME Micro WTI Crude Oil expiring in July (MCLN2023) with an entry of USD 71.90 a barrel with a target of 64.80, and hedged by a stop loss at 75.60, is likely to yield a reward-to-risk ratio of 1.9x.
RATTLED BUT RESILIENT. US CONSUMER SENTIMENT IS WEAKENING.
Oil prices face massive headwinds in the near term in line with frail U.S. consumer sentiment. It slumped to a six-month low as a debt ceiling drama fuelled worries about the economic outlook.
The University of Michigan's preliminary reading of consumer sentiment index clocked 57.7 pointing to the lowest reading since last November and down from 63.5 in April.
Consumer sentiment tumbled 9% wiping out over half of the gains achieved after the all-time historic low from last June.
While current macroeconomic data show little sign of recession, consumers’ worry about the economy escalated this month.
Expectations for the economy a year from now sank 23% from last month. Longer term expectations contracted 16% highlighting that consumers concerns that economic downturn will not be shortlived.
Consumers have demonstrated resilience thus far. But their anticipation of a recession will trigger to cut spending when signs of weakness emerge.
An unresolved banking crisis and a prolonging debt ceiling drama paint a dismal picture for US consumers. It will amplify if debt default drama continues this week with rising likelihood of default and the resulting economic consequences.
UNDERWHELMING CHINESE RECOVERY
The much-anticipated economic rebound never occurred, but to describe it as underwhelming might be an understatement.
Broad economic indicators point to weakening instead of recovery. Industrial production and retail sales missed forecasts. Unemployment rate among youth set a record high of 20.4%.
A frail global economy adds to China’s gloom. High inflation and elevated rates in China’s key destination countries have slashed demand for Chinese products. Exporters at China’s largest trade fair reported a drop in overseas orders.
Infrastructure and manufacturing investment, which have helped to offset the slump in property investment, both slowed in April from the previous month, a sign of more subdued government spending and weak business confidence.
The property market remains weak despite early signs of a pickup in housing sales. Consumers are reluctant to borrow. China’s home price growth slowed in April. Indicators show slowing momentum in home purchases despite Government’s effort to prop up the real estate. China’s housing starts is at its lowest when compared over the last 10 years.
Property investment shrank more than 16% in April YoY even though home sales grew. Construction of new homes continued to decline.
New household loans, posted the first decline in 12 months in April 2023, suggesting that residents repaid more than they borrowed.
NOT WEAK DEMAND BUT UNSEEN ROBUST OIL SUPPLY
More than Expected Supply
Given the gloomy headlines, it is easy to fall prey to the notion that demand is the problem. The real problem is too much supply, argues Javier Blas of Bloomberg.
Unexpected production is primarily coming from OPEC+ countries despite promise of supply cuts. Many oil producing nations are unknowingly participants of the prisoner's game.
Demand Remains Steady
The IEA raised its forecast for 2023 global oil demand by 400,000 bpd, setting a record daily consumption of 102 million barrels. In short, demand remains resilient.
IEA’s optimism may be misplaced, and oil demand growth might soften. But its forecast accounts for pessimistic diesel outlook.
Presently, the oil market has all its eyes on Washington. The US gulps two out of every ten barrels pumped worldwide. But America is not the oil market. Its consumption lead has narrowed significantly. In 2023, the combined consumption of China and India (21.4 million bpd) is expected to be larger than the US (20.3 million bpd).
The real hurdle holding back an oil rally is supply. The need for cash in producing nations forces them to pump more. These countries are trying to make up for lost revenues by ramping up volumes to compensate for what they are losing due to lower prices.
MANAGED MONEY ARE BEARISH AT LEVELS UNSEEN SINCE 2011
Net position of non-commercial players is at its most bearish levels since 2011 across a combination of major oil contracts.
Non-commercial participants include hedge funds, proprietary trading groups, asset managers, among others. Other Reportable Positions represent open interest by large participants that trade their own accounts and do not fit into any other category.
TRADE SETUP
Amid gloomy outlook and strong headwinds, this paper posits that a short position in CME Micro WTI Crude Oil Futures expiring in July (MCLN2023) with an entry of USD 72.00 with a target of 64.80, and hedged by a stop at 75.60, is likely to deliver a reward-to-risk ratio of 1.9x.
• Entry: 71.90 USD/barrel
• Target: 64.80 USD/barrel
• Stop: 75.60 USD/barrel
• Profit at Target: USD 710
• Loss at Stop: USD 370
• Reward-to-risk: 1.9x
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme/.
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
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