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Debate On Crude-Oil Price Direction Continues

Debate regarding whether or not crude-oil prices have bottomed continues in the market, but the one thing is certain, prices are volatile.

Oil prices sharp slide through the end of 2014 continued into 2015, touching a low of just under $44 a barrel for Nymex West Texas Intermediate in January. Since then prices have bounced around $50 as of mid-February, with some oil industry analysts, like Price Futures Group’s Phil Flynn, calling a bottom.

But his view is certainly not universal. Some firms, like Citi, are still calling for WTI prices to fall to the $20 range.

What’s helped pull oil prices off their lows is that U.S. oil-rig counts are down sharply, and as of mid- February, have declined 10 consecutive weeks. Rig counts are down 30% drop since the start of the year, Commerzbank analysts said.

“Clearly the expectation of a massive slowdown in U.S. oil-production growth is responsible for the dramatic price surge – the price has soared by 37% from its mid-January low,” the Commerzbank analysts said, adding that the drop in rig counts is the second-sharpest since 1987.

That’s a sign that oil producers are curbing production, but some oil-market watchers said more must be done.

“The rig count decline is still not sufficient, in our view, to achieve the slowdown in U.S. production growth required to balance the oil market,” Goldman Sachs said. “The flexibility in cutting non-contracted rigs and associated cost deflation along with the producer hedging that has occurred over the past weeks and the recent wave of equity issuance (raises) the risk that the U.S. production slowdown will be delayed. As a result, we reiterate our view that oil prices need to remain lower in the coming quarters in order for the announced capex guidance and rig reduction to materialize into sufficiently lower production growth.”

Whether or not oil prices have bottomed, analysts at Nomura said oil-price volatility persists, and the best way market participants can protect themselves is with hedges.

“Despite a rebound in oil prices, oil volatility has continued to surge, with the CBOE Oil ETF VIX index registering a weekly close above 60 for the first time since the global financial crisis. It is difficult to declare with conviction that oil is back in a bull market, and investors with oil exposure in their portfolios may find it prohibitive to hedge using oil/oil ETF options at current levels of volatility,” they said.

Instead, they said, investors could try cross-asset exposure.

One idea is to replace long oil exposure with short puts on United States Oil Fund ETF.

“For investors who want to have an upside exposure to the oil price, we recommend replacing the long commodity exposure with a short put on the underlying, with a strike equal to the price at which they would be comfortable buying upside in oil,” Nomura said.

Another idea is to buy Canadian dollar puts, which they said historically has a high correlation to the price of oil.

No matter what oil investors do, Nomura said, it’s worth considering cross-asset ideas to hedge existing or new longs in oil-related assets “as a cheaper way of covering downside risks. “

Debbie Carlson

Posted by Debbie Carlson

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