AEGIS Factor Matrices: Most important variables affecting oil prices

April 9, 2021
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Crude Oil Bottom Line – WTI finished Friday just shy of $60/Bbl, a loss of $2.13 from the previous week. The May WTI contract has traded sideways for the past four weeks, settling within a $3.80 range top to bottom. The lateral price action could imply a more stable supply and demand background as OPEC+ balances production increases with a demand recovery. As oil prices have relaxed, a faster end to the OPEC+ supply cuts seems less likely.

Concerns about the pace of demand improvements due to new lockdowns and OPEC+’s plan to increase production have kept price from rallying. The price recovery in late 2020 and early 2021 was due to supply restrictions, and the cartel continues to leave many millions of barrels on the sidelines to help support price. The demand recovery has been slow, but air travel is showing a quick revival since February, at least in the TSA lines.

Factors threatening oil prices are more severe lockdowns, progress on talks between Iran and the US, and OPEC compliance. It’s important to remember that those who systematically de-risk their portfolios tend to perform better in the long run. Traders relying on chart patterns are rightly perplexed right now, as prices have not established a direction.

To see details on factors we believe are affecting oil prices and trade recommendations, click the “Read More” button on the Factor Matrix section in the AEGIS Research Module.


Crude Oil Factors

OPEC+ Cuts. The large volume of OPEC cuts, about 8 MMBbl/d in 1Q2021, has helped the oil market recover from pandemic lows. On April 1, 2021, OPEC+ reach a consensus agreement to increase production gradually, beginning in May. In total, the output hikes will add more than 2 MMBbl/d to global supplies from May to July. The group did note that they would need to keep their finger on the oil markets’ pulse to prevent overheating and keep the inventory draw-down rate at a reasonable pace. We moved this Factor down to reflect it has become further priced in, as the cartel has continued to help oil price find footing as demand uncertainties continue to hang over the market.

Jet. Jet fuel’s demand recovery has been lagging behind other transportation fuels thus far. Vaccination rollouts in the U.S. and around the globe continue to pick up. It is possible that. demand for jet fuel could increase quicker than what many forecasting agencies (EIA, IEA, etc..) are predicting. If this comes to fruition, then crude demand would be much closer to pre-pandemic levels, which would help support crude prices.

Iran sanctions. The U.S. and Iran held indirect talks on April 6 to discuss possible solutions to bring both sides to the negotiation table. Rhetoric from the Biden administration hinted that the nuclear deal’s resurrection would not be likely in 2021. However, progress was made during the April 6 meeting that may clear a path to more output from Iran sooner than many had anticipated, according to Bloomberg.

China has been purchasing crude from the country despite U.S. sanctions, at sizeable discounts, driving down spot market prices, per Bloomberg. According to the Wall Street Journal, China is expected to import 918,000 barrels a day from Iran in March, which would make it the highest mark since sanctions were imposed.

Covid-19 Demand/Economy. We reduced this Factor’s size to effectively unbundle jet fuel demand from the other impacts of COVID-19 on oil demand. COVID-19 is still weighing on prices, with Europe serving as an example of how lockdowns can be reimposed if cases and death numbers rise. If cases were to get worse in the United States, this Factor could become larger and pressure prices further.

USD.  A cheaper dollar helps support oil (and other commodity) prices. Over the past few weeks, the dollar has flipped into an uptrend which may be weighing on crude prices. On March 26, the dollar benchmark (DXY) reached a four-month high. We moved this factor down to reflect that it has weighed more on price as the dollar benchmark has strengthened.

U.S. Production Growth. This factor represents the risk that U.S. producers pose in terms of added supply. Oil prices have improved dramatically, and the test will be how producers respond to higher prices. Will it be like in the past, where activity picks up at a feverish pace? Or will capital constraints and Wall Street disincentives keep output flat? In the upper left quadrant, this factor is a potential bearish surprise.

Saudi Arabia Compensatory Cuts. Saudi Arabia announced it would begin to restore output in 250 MBbl/d monthly increments starting in May. Prices held firm in response to the news, which should serve as a vote of confidence for returning demand. The kingdom did note that the policy is still flexible and that they would do what it takes to keep the market balanced. We moved this factor down to reflect it is further priced-in as the Saudi’s influence on the rally has potentially played out.

Fiscal Stimulus. The massive $1.9 trillion stimulus package was passed in the house on March 10 and President Biden signed the bill into law on March 12. The relief package, known as the American Rescue Plan, will send $1,400 checks to most Americans. The stimulus package is a supporting factor for oil prices and has the potential to increase oil demand as Americans have more disposable income to consume products/fuels. We moved this factor down to reflect it is more priced in.

Middle East Hotspots. The last few months have brought some renewed tensions in the Middle East. On March 7, oil prices spiked on news of an attack on Saudi oil infrastructure carried out by the Iran-backed Houthis. The escalatory move was the largest attack in recent memory. This is a potential bullish surprise.

Hedge Funds. Net-spec length from Money managers is back near June 2020 highs when WTI traded sub $40/Bbl. When Hedge funds have a lot of length in the crude market it can become a liability to crude prices if things were to turn south. Speculators usually don’t start move’s down or up, but they can exacerbate them as they are cumulatively on one side of the trade. This a new factor that we flag as a bearish surprise.

Lack of Drilling CapEx. If demand recovers (our target is late 2021), the oil market may face less supply and an inability to serve demand. With oilfield services understaffed, and providers of capital reticent to take a risk on energy, production may not be able to respond quickly to a price signal. Therefore, we view these two Factors as potential bullish surprises. We expect the timing of these Factors’ importance to be heightened toward the end of 2021.

Production Decline. Our first thought may go to the U.S., but global non-OPEC supply potential has likely diminished in the last 10 months. We think this Factor is well-understood and is priced in, but if production declines continue, the market may start to panic and send prices higher. Think of this as a late 2021 risk and balanced against the speed of demand recovery. In the near-term, we hear more and more examples of DUCs being used to support production volumes.

Commodity Interest Trading involves risk and, therefore, is not appropriate for all persons; failure to manage commercial risk by engaging in some form of hedging also involves risk. Past performance is not necessarily indicative of future results. There is no guarantee that hedge program objectives will be achieved. Certain information contained in this research may constitute forward-looking terminology, such as “edge,” “advantage,” ‘opportunity,” “believe,” or other variations thereon or comparable terminology. Such statements and opinions are not guarantees of future performance or activities. Neither this trading advisor nor any of its trading principals offer a trading program to clients, nor do they propose guiding or directing a commodity interest account for any client based on any such trading program.

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