In an April 23 Barchart article, I wrote:
The U.S. administration failed to replace some barrels sold since the massive SPR release began in 2022. If oil prices return to the $100 level, the missed opportunity will become a tragic mistake as the U.S. will have far less ammo to combat rising petroleum prices over the coming months. I am bullish on crude oil and believe buying dips and price weakness will be optimal.
On April 21, June crude oil futures had recovered from below $65 in March to over $78. After reaching an $83.38 per barrel high on April 12, the trend turned bearish, and nearby futures were back at the $70 level, in the sweet spot for the administration.
Crude oil runs out of upside steam for two reasons
After reaching the April 12 high, NYMEX WTI crude oil futures turned lower, falling back into the administration’s $67 - $72 per barrel target zone for SPR purchases.
The chart illustrates the decline that took June futures to a $63.57 low on May 4 before recovering to over $70 on May 17. The two factors that pushed crude oil lower were the fear of a recession caused by higher interest rates and concerns over the U.S. debt ceiling debate that could cause the U.S. to default on its obligations for the first time. Economic weakness is bearish for crude oil, a leading industrial commodity.
The administration kept selling over the past weeks
From January through March 2023, the U.S. Strategic Petroleum Reserve was at the 371.6-million-barrel level. The SPR fell from 595 million barrels at the end of 2021. The 37.5% decline to the lowest level since 1983 occurred as the administration sold crude oil to keep a lid on prices after Russia invaded Ukraine, and supply fears gripped the international petroleum market. The sales were at an average of around $96 per barrel.
In October 2022, the administration stated the target to replace the sales was $67 to $72 per barrel.
In December 2020, NYMEX crude oil futures fell to a $70.08 per barrel low. In March 2023, the low was $64.12; in May 2023, it fell to $63.57 per barrel.
Meanwhile, instead of buying for the SPR, the administration continued to sell.
The chart shows the drop in the SPR to just under 365 million barrels for the week of April 28, 2023. For the week ending on May 5, 2023, the crude oil in the SPR continued to decline, reaching 360 million barrels.
June could be the magic month for SPR replacement if the market cooperates
While the administration did not stick to its pledge to purchase oil at $67 to $72 over the past weeks and months, U.S. Energy Secretary Jennifer Grandholm told Congress her department could start repurchasing oil for the SPR after completing a congressionally mandated sale in June. She told lawmakers, “That congressionally mandated sale of 26 million barrels will be completed by June, and it's at that point where we will flip the switch and then seek to purchase.” She said the $67 to $72 target will trigger buying when prices are “consistently at or below” the level.
A floor of $60 to $70 per barrel
OPEC+’s last move was the cut crude oil production. Saudi Arabia requires around $80 per barrel to balance its domestic budget. Russia, a leading oil producer, and influential cartel non-member is funding its war efforts with petroleum revenues.
U.S. energy policy that inhibits fossil fuels and encourages alternative and renewable energy sources has strengthened OPEC+’s position and pricing power. If the administration finally follows through on its pledge to replace the SPR, it could put upside pressure on the price. Moreover, the plans for U.S. buying depend on crude oil’s price remaining at the current $70 per barrel level or lower.
I believe the $60 to $70 per barrel level is a floor for the energy commodity, and risk-reward favors the upside with nearby NYMEX futures at the $71.30 level on May 17 and active month Brent futures near $75 per barrel.
Trading the range with UCO and SCO- Time and price stops are critical when using leverage
Crude oil may settle into a trading range around the $70 per barrel on the nearby NYMEX futures contract, with a bias to the upside. While I favor the upside, a consolidation around $70 is possible.
Over the coming weeks, trading crude oil could be the optimal approach buying dips and taking profits on rallies. The most direct path to the WTI crude oil market is via the futures and futures options trading on the CME’s NYMEX division. The Ultra Bloomberg Crude Oil 2X ETF (UCO) and its bearish counterpart (SCO) seek to deliver a leveraged return on the up and downside compared to the nearby NYMEX crude oil market.
The most recent rally in June NYMEX crude oil futures took the price 29.1% higher from $64.58 on March 20 to $83.38 on April 12. The subsequent decline to $63.57 on May 4 took the energy commodity futures 23.8% lower. Over the same period:
- The bullish UCO product rallied 48.6% and fell 30.5% as the bullish ETF outperformed on the upside and underperformed the futures market on the downside.
- The bearish SCO product fell 33.9% and rallied 40% as the bearish ETF outperformed on the downside and underperformed the futures market on the upside.
UCO and SCO are liquid ETF products:
- At $23.81 per share on May 17, UCO had nearly $587 million in assets under management. UCO trades an average of over 3.6 million shares daily and charges a 0.95% management fee.
- At $26.67 per share on May 17, SCO had over $206.3 million in assets under management. SCO trades an average of more than 1.45 million shares daily and charges a 0.95% management fee.
If crude oil settles into a range, UCO and SCO are alternatives to the futures market for those looking to trade crude oil. Meanwhile, leverage requires market participants to pay careful attention to risk-reward dynamics as leverage comes at a price, time decay. Therefore, price and time stops are the optimal approaches when using UCO, SCO, or any leveraged derivative product. I continue to favor the upside in crude oil. Still, a consolidation period around the current level is possible as bullish and bearish factors pull the energy commodity in opposite directions in mid-May 2023.
On the date of publication, Andrew Hecht did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
