Are Oil Prices Set For A Comeback?

Marius Paun | London, UK | Senior dealer | Thursday, 26th November 2020

 

The announcement of positive news regarding coronavirus vaccines provided a reversal of fortunes for crude oil prices, which clearly regained some upward momentum. This week, President-elect Joe Biden also started a formal transition to power, thus removing some of the post-election uncertainties, which further helped the energy sector. Yesterday, despite some profit-taking in equities, oil prices continued their rally, driven by a surprise fall in US crude inventories by 750,000 barrels versus expectations for a 100,000 barrels build.

Looking back, the US crude prices have been a bit of a rollercoaster story this year. They spent 2019 in a range, largely between $50-$65 and then the pandemic sparked a violent selloff, rarely seen before. The panic was accentuated by an excess of supply with not enough storage capacity. We all remember oil futures going negative in April! The contracts holders were forced to sell to close positions to avoid taking delivery as oil storage was running almost at full capacity. We saw a gradual recovery after that, pushing the prices up to $43.85 in late August, followed by a slight pullback for the next two months. Since the US elections crude turned back up once again, touching levels last seen during March collapse.

Investors are now trying to gauge a fair valuation for crude prices using comparison to other asset classes. Relative to stocks, oil is very cheap, indeed reminding us of the late 1990s when crude was around $10 a barrel. It was the beginning of the massive bull run in commodities which took its price close to $150. Same goes for its price relative to gold, that ratio is now at multi-year lows. It’s the very reason that many analysts are saying the current environment is resembling ‘the roaring 20s’ – the extraordinary boom time of 1920s. If one considers the jaws dropping monetary stimulus with ‘lower for longer’ interest rates, quantitative easing pushing money supply growth to extremes, it does not seem that far-fetched.

No doubt that lockdown measures following Covid – 19 has destroyed a good chunk of oil supply. But now demand is set to rebound. People will start to travel again (heard the term ‘catch up holidays’ being bounded about recently?). Infrastructure in the Western world needs an upgrade. Climate change is one of the top subjects concerning voters if recent polls are anything to go by, and policymakers around the world got the message loud and clear. They are hell-bent on cutting growth in global carbon emissions. The ‘Green new deal’ mentioned so much by Joe Biden will need a lot of oil to build that massive renewables picture. From an investor point of view, the trend is set in motion, the world is going green, but can’t discard oil just yet.

There is also the portfolio rotation story we saw in the financial media in the last few weeks: sell coronavirus winners, stay at home stocks etc and buy coronavirus losers, hospitality and travel stocks which will need a lot of oil to recover. It is yet another the reason why the energy sector is the best performing sector in the US in November, up 25%. Industrials and financials are also higher by more than 15%.

Another driver for crude oil’s rally in the recent weeks was the expectation that the OPEC+ coalition could delay, by 3-6 months, a planned output cut scheduled initially in January 2021. However, there may be some headwinds ahead. Iraq joined UAE in complaining about the compliance of ‘other members’ specifically Russia and added the allocation quota is rather unfair. A shorter time frame and /or a surprise reduction in size cannot be discarded. OPEC is notorious for being united when oil prices are collapsing but less when they rebound.

The US President-elect Joe Biden nominated Former Fed Chair Janet Yellen as his Treasury Secretary who, along with Jerome Powell, is expected to unleash a massive fiscal and monetary stimulus which should benefit crude prices going forward.

 

The chart above shows the uptrend has resumed as the multi-month resistance at $43.85 has now been broken. The short-term moving averages is now above the longer-term moving averages and both point higher. The price is now above both indicators. If anything, the price action looks a bit frothy, so today’s pullback is probably welcome by the bulls as a breather for the next potential leg up.

On the upside, buyers will be looking for a close above $46.28, yesterday’s high. There’s very little resistance beyond that until $48.5, the high of March this year. On the downside bears will have their eyes on breaching resistance turned support at $43.85 which looks like a fairly big ask. However, a breach below that could attract enough sellers who will be keen to test the $42.7 and $42.3 levels.