The case for $50 oil

Oil markets appear to have successfully overcome a great wall of worry, with oil prices rebounding to multi-year highs. Brent oil reached a nearly three-year high at $77.25/barrel, its best level since October 2018, while WTI closed trading on Thursday at $73.30/barrel, marking its highest settlement since July.

Behind the bullishness is a growing optimism that looms impending debt problems China Evergrande Group (OTCPK:EGRNF) (OTCPK:EGRNY) may be contained, coupled with a lack of aggressive surprises from the Federal Reserve. The Fed recently announced its winding-down plan, confirming its economic optimism. Demand for oil is growing steadily amid an ongoing economic recovery, while the supply outlook remains stable thanks to OPEC+’s manufacturing discipline.

Meanwhile, the bullishness is compounded by the latest EIA report showing US crude inventories have declined for the seventh week in a row. US crude inventories fell 3.5 million barrels to 414 million barrels last week, according to the US Energy Information Administration. lowest level since October 2018. The EIA report was generally bullish and said inventories will only worsen in the coming weeks due to inventory stretches and the fact that refineries are rebounding faster than crude oil supplies are growing.

But another Wall Street bear is warning the oil bulls not to drive a victory lap yet.

In a recent tweetAccording to Bloomberg Intelligence’s senior commodities strategist Mike McGlone, several commodities, including crude oil, may have peaked and may be heading for a “return to the mean,” ie a major pullback.

Iterations for a lasting commodity spike are mounting and the stock market could be the last crutch. US Treasury yields peaked in March. Copper, maize and timber peaked in May. The dollar has recovered since June and crude oil may have peaked in July when China lowered its required reserve ratio.

Return to the mean

McGlone notes that commodities have become highly dependent on rising stocks, and says a stock market stress test is needed to determine which commodities are most likely to sustain higher prices and which to fall.

Unfortunately, he says that oil, copper, corn and wood belong to the latter category.

McGlone notes that the last two major declines in crude oil (2018 and 2020) were almost tick-for-tick with the S&P 500. The 20-quarter correlation between the Bloomberg Commodity Spot Index and the S&P 500 currently stands at 0.90, the highest level since 1960. The BI analyst says the correlation last peaked in 2013, followed by the spectacular oil price crash of 2014, which then spread to the rest of the world. resource complex.

Now there is a risk that WTI will return to its average since 2014, which would mean a drop to about $50 a barrelMcGlone says.

McGlone says there is another bearish catalyst that is thwarting oil prices: supply elasticity due to technological advancement.

Five years ago it cost about $50 to extract a barrel of crude shale, now it’s closer to $30. Companies have adapted to Covid-19, as our chart shows S&P 500 Ebit at an all-time high. If stock prices fall or profits stagnate, the highly correlated commodity market risks a faster decline.” McGlone wrote.

Skimming stones

Bloomberg Intelligence isn’t the only technical analyst to be bearish about the oil price outlook.

Last month, Standard Chartered Global Research described the current oil price cycle as a “skimming stones” trading period.

The research group noted that the broad pattern over the past three months has been one of sub-cycles of rallies from starting points below USD 68/bbl for Brent, followed by reversals. Unfortunately for the bulls, the cycles have become flatter and faster, with Stanchart saying the next move will likely be downward.

Related: Oil Trading Giant Trafigura Sees $100 Oil By Late 2022

According to Stanchart, the first subcycle of skimming stones began in late May, culminating with a Brent high of $77.84/bbl six weeks later. The next subcycle started on July 20 below $68/barrel with a high of $76.38/barrel two weeks later.

In the graphs, this pattern looks like skimming bricks where each bounce is less high than the previous one and the length between bounces gradually decreases.

Stanchart has predicted that the end of the skimming stones phase will bring a period of consolidation, followed by a downward movement.

Stanchart says that while the possibility of oil markets returning to bandwidth-bound conditions remains, the current momentum in fundamentals, especially the surge in the spread of the delta variant, makes an eventual downward breakout more likely.

The Stanchart researchers have strongly refuted Wall Street’s bullish views by saying that the WTI price of $65/barrel or lower is more likely than $75/barrel or higher. Stanchart says his bearish stance is based on the fact that “…a significant amount of money has already entered the market in the Wall Street-generated belief (wrong in our analysis) that the balances are much tighter and warrant $80-100 a barrel.”

Well, right now we’re more concerned about Fed policy.

With the Fed starting to phase out bond purchases as early as November and raising interest rates in response to rising inflation, the dollar looks poised for an upward trajectory, which could be bad news for oil prices and other commodities.

By Alex Kimani for Oilprice.com

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