Oil's Retreat From $40 Is Surprising No One
Just after the International Energy Agency said that oil prices may have bottomed, the price of Brent crude dropped over $1.25 a barrel Monday. Analysts pointed to Iran’s announcement that it will continue to increase its output as a bearish factor. But it could just be that traders saw $40 as a good place to take profits.
When markets reach all-time highs or lows, it becomes a kind of game for pundits, economists, and various analysts, not to mention actual traders, to guess whether we’ve reached the top or bottom. When the stock market made its long bull run from 2009’s low, the game began in earnest when it approached and finally topped the pre-crisis high and later, the previous all-time high set in 2000, when the S&P 500 pushed above 1600.
Stocks are once again approaching the all-time highs set last year and the calls for a bear market or even a recession have quieted. The new game is declaring whether crude oil will drop further than its lows around $30 and test the next round number down, $20 a barrel.
$20 is just the latest number experts are calling out as an absolute bottom. Shale oil billionaire Harold Hamm called it at $80 a barrel, interestingly just above the production cost of North American shale oil. Vitol, the largest energy trading company in the world, called it at $60. Qatar’s oil ministry called it at $46, interestingly just above Qatar’s cost of production at $41. And now with crude testing $40 again, the IEA is saying the mid-20s we saw last month was the low and we won’t go as low as $20 a barrel.
Well, maybe. Twenty dollars a barrel is just above the cost of production for Saudi Arabia and Kuwait and unprofitable for just about everyone else. But that’s not the only reason $20 is an oft-mentioned number. The other reason is that it ends in zero.
It’s a truism that traders use round numbers as mental milestones as well as profit targets and stop-loss levels. The S&P 500 danced (and still dances) around 2000, the Dow around 17,000, and gold around $1200 an ounce. Why? Those numbers have no significance other than being round and extreme.
That, as much as any other reason, may be why crude oil stopped and reversed course once it reached the magical level of $40 a barrel. Some traders would have bid the price up just to see it print, the way people watch their car’s odometer flip over. The more serious-sounding reason, however, was statements by Iran’s oil ministry that Iran was planning to sell as much oil as possible now that sanctions have been lifted.
For some reason, this came as a surprise to some observers. “Iran maintains its right to increase its oil production until it reaches its pre-sanctions level,” Iran’s deputy oil minister told Seda Weekly.
Oil Minister Bijan Zanganeh was clear about what he wanted from fellow OPEC members and the world until then. “They should leave us alone,” he told the Iranian Students News Agency, until Iran was back to pre-sanction production levels. “After that we will work with them.”
However, Iran’s increased output may well be offset by declines in Iraq, Nigeria and the United Arab Emirates as well as outside OPEC, most notably the ongoing shutdown of shale oil drilling operations in North America. In short, overall global production of oil isn’t changing that much. It was a glut and it remains a glut but it’s no more of a glut now that Iran is back in the game.
So if supply—or oversupply—is not the reason for crude oil’s failure at $40 a barrel on Monday, that leaves just one reason. People who went long in the low and mid-30s saw a nice round number as a good place to take profits. One sign of that is the low volume on the big drop Monday morning. That suggests that longs were able to trade out of their positions, but very little short-selling volume came in on top of that.
Markets love to retest highs as well as lows. With no real changes in the underlying supply and demand, oil may well stay in the range between $20 and $40 for some time. Long enough, perhaps, for Tesla, Chevy, and others to come out with their new sub-$40K electric cars. It’s certainly possible for oil to go above $100 a barrel again, maybe even within the next couple of years. The real question is, will as many people want to buy it when it does?
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