FX.co ★ Oil at $100 this summer?

While the attention of traders is riveted on the falling stock market, and questions about the depth of the fall are spinning in their heads, it's time to think about what seems impossible now from the point of view of simple human logic: is oil at $100 a fantasy or a future reality?

At first glance, such an assumption, specially made in the face of a falling market, seems incredible, but only at first glance. In January, several large banks made forecasts about the further growth of oil prices.

Analysts at Bank of America said that oil at $100 per barrel and above is possible already in the second quarter of this year, linking the price with an increase in demand and the lack of spare capacity to increase production. Goldman Sachs expects the oil price to rise to $100 this year and $105 in 2023. JP Morgan went even further, suggesting an increase to $125 this year and $150 in the future, which should happen against the background of insufficient investment in oil production.

At the moment, most of the reserve capacity is concentrated in Saudi Arabia and the United Arab Emirates. However, these two largest producers in the current situation are doing everything to reach the planned indicators within the framework of the OPEC+ agreement, and will use their reserve capacities for this.

Thus, if the OPEC+ countries continue to increase production by 400,000 barrels per month, they may soon have no reserves left for production, because the rest of the cartel countries are lagging behind and cannot increase production. At the same time, Saudi Arabia and the UAE and their infrastructure are being attacked by the Yemeni Houthis. Even Russia is now experiencing difficulties with increasing production, producing an additional 60,000 barrels per day instead of 100,000 allowed for a monthly increase.

According to Bloomberg estimates, by July 2022, at the height of the season, OPEC+ spare capacity will be reduced to only 2.3 million barrels per day, which will be the lowest level since 2018. Moreover, the Persian Gulf countries will be the only ones who will be able to increase production within the limits of the existing quotas for an increase, and all this will happen against the background of a record reduction in reserves in the OECD countries, which will fall to the lowest values over the past 20 years (Fig. 1).

Figure 1: Commercial oil reserves in OECD countries.

Of course, taking advantage of high prices, the USA, Canada and Brazil are likely to increase oil production this year, however, due to financial constraints and stricter capital management discipline, U.S. shale producers will most likely not be able to return to production levels in 2018-2019, despite the fact that global demand is likely to exceed the pre-pandemic level this year. The dark horse remains Iran, which is under U.S. sanctions, which can supply up to 1 million barrels of oil per day to the market, but this oil may simply not be enough to meet the growing demand.

However, the theory is good if it finds its confirmation, no matter what numerous analysts assume, traders and investors make decisions based on their own views on the situation, often basing decisions on the analysis of the graphical display of the dynamics of quotes.

When looking at the chart, you can see that the American grade of WTI oil, despite the market decline, overcame the resistance of $84.65 (Fig.2), which opens the way up.

Fig. 2: Technical picture of WTI oil in 3 Line Break format

The decline in the stock market, which is taking place this week, has again driven oil under the bar, but there is no drop similar to what we see in the stock market in the oil market. This is strange, but indirectly indicates that oil is very strong, is in an upward trend, and is ready for further growth. From the point of view of technical analysis, the target of the increase is now near the level of $97, and there it remains quite a bit to the level of $100, which is called close at hand.

If we talk about the positions of traders in the futures markets, known to us from the Commitments of Traders – COT report, now they also favor price growth. The demand for oil, expressed by Open Interest, is growing, and in three weeks it has grown by more than 10%, to the level of 2.7 million contracts. Money Managers, who are the main buyers, increase long positions and close sales. Swap Dealers who insure their risks are actively selling oil futures and options, which may also indicate a positive mood in oil quotes.

At the same time, traders who open or plan to open oil purchases, as well as investments in oil-producing companies, should not forget about the possibility of falling stock markets against the backdrop of the U.S. Federal Reserve meeting, which will end on Wednesday, January 26, as well as opposition to price increases from the administration of President Joe Biden.

In the first case, we may encounter the so-called "margin call" phenomenon, when, against the background of falling stock market value, investors are forced to close all their profitable and unprofitable positions in order to make up for the missing margin. However, in the current situation, there is more than enough money, so there may not be a decline similar to what we saw and experienced in March 2020.

In the second case, the Biden administration desperately needs the price of oil to fall below $80 per barrel again, because, for every cent higher, U.S. consumers lose a billion dollars a year in additional costs. As Simon Watkins, an analyst, trader, and journalist wrote: "The danger for a U.S. president in oil prices being above these levels for any prolonged period is twofold. The 'danger zone' for U.S. presidents starts at around US$3.00 per gallon and at US$4.00 per gallon they are being advised to pack their bags in Pennsylvania Avenue or start a war to divert the public's attention."

The problem is that gasoline prices in the United States have already exceeded the psychological threshold and are in the range of $3.00-$3.75 per gallon, diesel fuel is even more expensive, 3.78-4.82, while oil does not decrease even under the weight of a strong dollar. At the same time, citizens living in the United States have already noted a drop in cargo volumes, which is uncharacteristic for the U.S. Therefore, the U.S. president urgently needs a war. Guess where?