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Crude Oil Makes New Highs as U.S. Inventories Fall for Tenth Straight Week; US Dollar Volatility Skewed Price to the Upside

In a week of political whiplash, the US Dollar stands on uncertain ground as traders grow weary of signals from the White House and Department of the Treasury. The US Dollar has been facing heavy selling pressure in recent weeks as the market rotates into other currencies such as the Euro or British Pound. The vulnerable dollar was hit full force last Wednesday by comments made by Steven Mnuchin at the World Economic Forum in Davos. Mnuchin stated that he preferred a weaker dollar as it offered the US better opportunities for global trade. The comment breaks with roughly 25 years of strong dollar policy from the Department of the Treasury. Later in the day, Commerce Secretary, Wilbur Ross, tried to undo Mnuchin’s misstep, but was unable to offer substantive support. The US Dollar Index fell from 90.072 to a low of 89.174 during Wednesday trading. The index fell for the next two days and reached a low of 88.438.

For the week ending 1/19/2018, the EIA reported a draw of -1.07 million barrels for commercial crude. Motor gasoline inventories showed a significant build of +3.098 million barrels and distillate fuel oil had a slight build of +0.639 million barrels. The draw in commercial crude marks the tenth straight week of declines as inventory reaches levels not seen since the beginning of 2015.

The acceleration in US inventory declines and a weaker US Dollar have supported prices in crude oil and its products since December with WTI futures rallying from $59 to $66 per barrel. We are growing increasingly cautious at these levels as a corrective move lower may be just around the corner. Comments from President Trump late last week offered support for the US Dollar as he contradicted Mnuchin’s weaker dollar position. The president’s statement on a stronger dollar could offer short-term support for the US Dollar Index and see it trade back above 90. Given the dollars strong negative correlation with oil, we expect any corrective move in the index to translate into losses for the energy complex.

In addition to a stronger dollar, global supply & demand and current speculative positioning are substantial threats to higher oil prices. Current projections for 2018 show global supply outpacing demand by an average of 0.22 million bpd. The average oversupply is expected to increase to 0.34 million bpd during 2019. The EIA has growth in US production as the driving force behind the oversupply with an average year-on-year percent change of 9.66% for 2018, and 5.62% for 2019. A pricing model for WTI futures based on the EIA’s projections show an average target of $70.15 for 2018, and $66.96 for 2019. Aside from a collapse of Venezuela’s oil production, OPEC may be unable to absorb further increases in US production given their current supply cut compliance of 128%. As such, we may see the $70 to $80 range serve as an upper bound for oil over the medium to long-term.

Speculative positioning hints at a threat of reversal as hedge funds show signs of weakness at historic levels. The commitment of trader’s report from the CFTC as of 1/23/2018, posted a decrease in the Hedge Fund Ratio for NYMEX WTI to 14.17 from 16.70. This is the largest one-week reduction in the ratio since mid-2017. Additionally, we are seeing an increase in short interest at these levels as hedge funds add almost 6,000 short contracts while the number of long contracts remains roughly flat.

Deeper on the technical side, WTI futures are painting a slightly bearish picture. A standard MACD and Relative Strength Index (RSI) are showing minor divergence via lower highs as price makes higher highs. Today’s price action has seen the RSI trade below the 70% threshold, indicating a potential shift in short-term momentum. Recent lows near $63.00 serve as support and a point of inflection. The overall trend in crude oil is still up and these technical indicators are by no means definitive, but we are watching major inflection points closely and keeping an eye on inventory estimates from the EIA. The overextension of the market leaves price susceptible to pullbacks on any structural weakness.