It's Slick In The Oil Patch: What Are Crude Oil Futures Saying About The Prices Ahead?

Investors know how volatile the commodities markets can be. When it comes to crude oil futures, it is a whole new ballgame with intraday as well as overnight volatility.

For example, based on Monday’s range ($86.82-$92.10), the price fluctuation on one contract is $5,280. That does not include all the intraday fluctuations that can result in $1,000-$2,000 moves in minutes.

All of the price references in this article will be based on the rolling front-month contract using data from the Tradestation platform.

The Big Picture: Some technicians peg the pandemic low in crude oil at a negative number, such as the April 2020 low of negative $6.43. To this author, that was a one-time anomaly induced by frenzied trading at a time the world was at standstill.

While the April low based on the TradeStation data is $5.12, the reality is the time it spent under $10 in April and May was brief. Once the contract proved it could hold $20 in November, along with the world reopening, the pace of the rally greatly accelerated.

On the upside, Russia’s invasion of Ukraine in February induced an oil scare, pushing the front-month contract to $120.59, That area was revisited in June, but so far the September contract has been in double digits for the entire month of August.

What The Pros Are Thinking: During the entire rally in crude oil, the contracts have been in backwardation as opposed to normalized contango.

Contango and backwardation are terms used to define the structure of the forward curve. Contango means the forward price of a futures contract is higher than the spot price. The opposite is that when a market is in backwardation, the forward price of the futures contract is lower than the spot price.

In simple terms, the professionals believe the higher prices for crude are unsustainable over the long-term and either supply will increase or demand will decrease, resulting in lower prices.

Reasons For The Recent Volatility: While investors are trying to determine if the U.S. economy is heading for a long overdue recession, there are strong indications the Chinese economy is slowing down.

A simultaneous decline in both economies will no doubt reduce the demand for crude oil at a time when supply is reaching its maximum to take advantage of the relatively high prices that crude oil is yielding.

As evidenced by some key economic data coming out of China overnight that came in below expectations, the Chinese government is lowering its interest rates in an attempt to jumpstart its economy. As a result of the weak data, crude oil futures made a new five-month low and are attempting to rebound.

Oil Moving Forward: When working on the premise that the pandemic lows for crude oil were artificially depressed and recent highs were artificially inflated, what is fair value moving forward?

For now, the experts are still pricing in lower prices ahead as the commodity remains in backwardation. If the spreads between the closer month contracts begin to narrow from approximately a negative $1.50 discount and creep toward par are even going into contango, the long-term bull thesis and sustained prices over $100 or higher may be validated.

For now, the threat of worldwide recessions and the eventual transition away from fossil fuels support the bear thesis for crude oil futures.

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