Playing Crude

It’s Presidents Day, and that means the U.S. stock and bond markets are closed. So today, I’d like to share with you this classic article from Dec. 21, as these ideas are still valid. Just keep in mind that financial system distress emanating from Europe could easily trump the crude oil price dynamics we look at below. Barring a crisis of confidence in the financial system, oil seems to be flashing a nice opportunity to buy. — JR

JR Crooks

You probably heard the price of crude recently touched a level not seen in 13 years.

Before that action, Goldman Sachs reminded us they put a price target at $20 per barrel, potentially.

More recently, the Organization of the Petroleum Exporting Countries (OPEC) — perhaps better known as Saudi Arabia — chose to scrap their production quotas.

Officially, that is.

Because, unofficially, pretty much everyone realizes the global crude oil glut is the result of Saudi Arabia’s limitless production during the last several quarters.

And we all know the North American shale revolution has contributed meaningfully to the supply glut.


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After the crude oil inventory numbers showed a surprise drawdown two weeks ago, last week revealed a surprise build.

Forecasters were blindsided by the inventory build because they didn’t expect a surge in U.S. crude oil imports.

So what gives?

Saudi Arabia.

U.S. crude oil imports surged from November to December. The culprit is probably the production cuts by North American producers. Drilling has dried up.

And who is there to scoop up market share when the Gulf Coast refiners want oil?

Saudi Arabia, among others.

So inventories are high and crude oil sits just above $35 at the time of this writing.

Is the play for $20 per barrel, like Goldman Sachs suggests?


But maybe not at first.

But look at this chart — the decline in October looks to have sufficiently extended in November and December.

This suggests crude oil is at a near-term bottom.

If crude doesn’t just meander for several weeks, a rebound would take it first into the low $40s and then a secondary thrust into the upper $40s.

Before jumping on this idea, though, any reasonable trader would wait for a day or two of upside momentum.

But if you want more reason than a day of price strength, consider that crude oil might be "due" for a rally.

Large speculative traders have significantly reduced their bullish bets on crude oil. The last two times those bullish bets receded as much, crude bounced sharply.

Here is another way of looking at crude traders’ sentiment — bearish bets have risen dramatically.

Bearishness today rivals the levels last seen in March — which, as the previous chart shows, is when crude experienced a legitimate rally.


Do you feel lucky?

Do you feel like now is the time to take a bullish bet on crude oil?

If so, you can use an ETF like the U.S. Oil Fund (USO) or a leveraged bet like the ProShares Bloomberg Ultra Crude Oil ETF (UCO).

Or, if you like the potential for select oil producers’ shares to rally in this environment, consider ExxonMobil (XOM) and EOG Resources (EOG).

Obviously, ExxonMobil is a supermajor. It’s an integrated energy company that stands out among its peers when it comes to financial position, dividends and operational success in a low-price environment.

I don’t particularly like the idea of putting money into "big oil." Think of it as an ethical dilemma that goes beyond hyped-up environmental concerns.

But ExxonMobil is my first choice in that segment of energy names. And a chart of XOM suggests shares are set for a secondary thrust that extends the move that began last quarter.

A test of the November high means a 10% rally. A 100% Fibonacci extension would mean a 20% rally in XOM.


Leaving the supermajor segment, a solid shale company is EOG Resources (EOG).

Sure, they’ve been hit by low oil prices the same way their competitors have.

But EOG’s operations are more nimble — they have tapped wells that they can bring online in a hurry if prices warrant. At the same time, their solvency is good. That’s quite an achievement in an industry as thoroughly beaten-down as energy.

Defaults are likely to increase as distressed producers give up. But EOG certainly isn’t one of those companies on the verge of throwing their hands in the air in defeat.

A chart looks good, with a potential 25% rally if a Fibonacci extension level is anything to go by.

That is a technical target in every sense.

I’d never argue that fundamental reasons are going to drive a 25% increase in any U.S. producer starting today.

But based on my experience with pattern analysis, as well as my understanding of how price influences fundamentals, I wouldn’t rule out such a rally from here if the underlying price of crude oil rebounds in the way I outlined earlier.

So, do you feel lucky?

Then play.

Do right,

JR Crooks

“JR” specializes in trading commodities, currencies and options. He has spent nearly 10 years analyzing financial markets and writing about global economics. JR honed his trading techniques and global-macro worldview alongside his father, Jack Crooks, at Black Swan Capital. JR also …