The Bullish Case for Oil Is Lining Up

Technology has picked up the slack for U.S. shale producers in recent years. Advances in efficiency have propelled the U.S. into the top spot when it comes to global energy production. Yet, rig counts are at two- to three-year lows in crude oil and natural gas.

We suspect there is a limit to how much production can be squeezed out of operations largely void of infrastructure and exploration expenditures. Further, it can be assumed that domestic producers will act as lame ducks ahead of the election season. Regardless of which side of the aisle you find yourself, there are only two viable (reasonably electable) names on the ballot, and they are polar opposites on energy policy. Thus, assuming producers will remain on standby for the results before making operational decisions makes sense. This will likely delay the possibility of increased production, which will support prices.

Market participants have become somewhat desensitized to supply disruption stories such as Houthi rebel attacks on transportation ships, the Russian/Ukraine war, and, of course, the war between Israel and Hamas. Nevertheless, these fundamental threats remain active and, in some respects, are flaring up. Eventually, this could lure speculators back into the market.

It might not seem like speculators have exited the oil market because it is a commodity at the forefront of most business news coverage, but they have. According to the Commitments of Traders (COT) report issued by the Commodity Futures Trading Commission (CFTC), the large speculative group of traders is net long less than 250,000 contracts. To put this into perspective, we have seen large speculators long as many as 740,000 contracts.

A year ago, we witnessed large speculators drop to a net long position near 180,000 contracts, followed by a $30.00 rally from $65.00 per barrel. Prior to that, we hadn’t seen the group this light in their bullish positioning since 2016; on that occasion, prices rallied about $50.00 per barrel starting from the mid-$20.00s. Additionally, during the financial crisis, there were a few instances in which speculators held similarly small net long positions, followed by rallies of $40.00 to $50.00. In other words, trader positioning suggests a substantial amount of buying power on the sidelines capable of propelling prices higher if market participants are given a catalyst to get back into the oil market. Will we get a $40.00 to $50.00 run higher from the most recent low? Probably not, but $20.00 to $30.00 is doable.

Over the last 30 years, oil prices have had a habit of finding a low early in the year (January through March) and a high later in the year (October through November). Further, a late June dip is commonly the start of a leg higher. Thus, there is a bit of a tailwind for oil prices for the next three months.

We will spare you the monthly oil chart that we have been sharing obsessively for years, but we will confirm the decade-long uptrend in oil, which is nearly $72.00, held in early June to produce a $10.00 recovery rally. Assuming the monthly chart isn’t misleading us, $100.00 oil is still in play. Yet, the daily chart offers a dose of reality. Even if we see triple-digit oil, there will be bumps along the way. The first hurdle will be $82.00; if we can’t get above $82.00 in the coming days, a pullback to $77.00 or even $74.00 is likely. If we trade and close above $82.00 sooner rather than later, we will run into resistance again near $87.00. There is no easy money in commodities.

Conclusion

The bullish case for oil is lining up, but it will be a bumpy ride. Seasonals, technicals, fundamentals and even market positioning suggest that the most probable direction for oil prices is higher. Should we see a typical year, the seasonal rally could extend into October. That gives speculators, who appear to be sitting on sidelined cash, plenty of time to bid prices closer to $100.00. 

At the time of publication, Garner had no positions in any securities mentioned.