During an economic recovery, future demand expectations trumps current supply data bidding up futures for crude and refined products. This is why the energy complex has been on a relentless upward trend for the past two years. Seasonal refinery output factors that normally temper price movements have had little effect this year. Why is this happening?
The simple answer is that speculators have gone all in on long positions, taking profits at resistance levels and then repositioning long trades at support levels. This has prevented any sustainable sell off. It has also positioned term structures to move from a well supplied backwardation market to a high demand contango market.
The EIA released gas supply data last week showing gas supplies have been steadily increasing. Despite the ample supply, they are giving a 10% probability that retail gas prices will hit $4.00 per gallon, with a 50% chance of gas prices hitting $3.50 per gallon in 2011.
One hope for consumers is that everyone is leaning heavily to one side of the ship. Should a major demand or several demand reducing events occur in 2011, there will be a lot of traders trying to exit through a small door at the same time. Such an event would be China overshooting on its attempts to dampen its inflation. Another listing of the ship event would be the failure of several Eurozone banks.
Since neither of these events are highly likely to occur, traders will not try to rock the boat and continue positioning for the likelihood of a continued bull market.
Saturday, January 22, 2011
Saturday, January 8, 2011
Falling Bond Prices Effect on the Energy Complex
Ben Bernanke and the US Federal Reserve are in the process of buying up $600 billion in treasuries in hopes of keeping interest rates low to help stimulate the economy. Bonds, however, are misbehaving. Interest rates on the ten year note is approaching critical technical levels that if broken, will likely set the stage for a secular bear market in bonds. Mr. Market is in the process of breaking apart long held economic theories.
Theoretical economics can be completely mind blowing. Yet no matter how complex the theory, in the long run, it will always need to obey the very simple laws of supply and demand. The acid test of any economic theory is whether or not a hypothetical idea plays out in the market. Ben Bernanke is hoping that injecting $600 billion into the economy buying treasuries will force interest rates down. Yet interest rates are going in the opposite direction. Why? And will this have any effect on the energy market?
The simple answer to why interest rates are heading up instead of down is that money flows are moving out of bonds with fears of future inflation diluting value.
Bonds have been in a secular bull market for the past twenty years. Bond traders are now carefully monitoring two year resistance of 4% on the ten year. Should this level give way the next major line of resistance comes in at 5.5%. A breach of interest rates above 5.5% by either the ten year or thirty year bond will be a strong signal to most bond traders that the long run of the bond bull market is over and a new secular bear market has begun.
If the bond market turns secularly bearish, will this tame the relentless bull market in energy? Probably not much. Upward trending interest rates are not good for any economy. Higher borrowing costs will be past along to consumers. The ultimate result is rising prices; inflation.
Crude oil remains a scarce resource. Light crude oil even more so. Long term continuation of falling bond prices will eventually lead to another recession. This may not happen for several years. Until then, demand for crude and its refined products will continue unabated supporting prices, keeping the secular crude bull market in place for several years to come.
Theoretical economics can be completely mind blowing. Yet no matter how complex the theory, in the long run, it will always need to obey the very simple laws of supply and demand. The acid test of any economic theory is whether or not a hypothetical idea plays out in the market. Ben Bernanke is hoping that injecting $600 billion into the economy buying treasuries will force interest rates down. Yet interest rates are going in the opposite direction. Why? And will this have any effect on the energy market?
The simple answer to why interest rates are heading up instead of down is that money flows are moving out of bonds with fears of future inflation diluting value.
Bonds have been in a secular bull market for the past twenty years. Bond traders are now carefully monitoring two year resistance of 4% on the ten year. Should this level give way the next major line of resistance comes in at 5.5%. A breach of interest rates above 5.5% by either the ten year or thirty year bond will be a strong signal to most bond traders that the long run of the bond bull market is over and a new secular bear market has begun.
If the bond market turns secularly bearish, will this tame the relentless bull market in energy? Probably not much. Upward trending interest rates are not good for any economy. Higher borrowing costs will be past along to consumers. The ultimate result is rising prices; inflation.
Crude oil remains a scarce resource. Light crude oil even more so. Long term continuation of falling bond prices will eventually lead to another recession. This may not happen for several years. Until then, demand for crude and its refined products will continue unabated supporting prices, keeping the secular crude bull market in place for several years to come.
Saturday, January 1, 2011
Will Crude Gain Another 15.1% in 2011?
The year 2010 was a great year for the bulls in almost every market. Equities around the world were higher. Gold, crude, bonds, US dollar, copper, wheat, corn; all paid handsomely to market participants trading long. With the economic recovery continuing to gain momentum, should traders simply repeat 2010 winning strategies, or has the long only trade become too crowded for 2011?
For energy traders the key to future prices heavily rests on future demand. Since the US and China are the two largest energy consumers, an investor's energy demand forecast for these two countries, will largely dictate the proper trade.
China is imposing higher reserve requirement and higher interest costs for banks to slow down growth. The Chinese government will likely be successful slowing growth. Still, they will likely continue to see GDP growth at 8% or better in 2011.
One other important factor in China's crude consumption overlooked by many is China's desire to build greater emergency reserve capacity. I like to call this factor the Chinese put. When crude prices dipped down into the $70's handle last summer, crude tanker shipments into China increased. Why? China has become an astute energy trader. They were busy buying up all available crude at cheaper prices and placing the barrels into emergency storage. They will repeat this exercise on any major market downturn, effectively giving long traders a free stop loss put.
With all the talk about China, the United States is still the number one consumer of crude, gas and diesel. Should the US fall back into another recession this year, energy prices will be affected dramatically. Unlikely as this might be to happen, traders will need to keep monitoring events in Europe that would have the potential to derail the US recovery. The problems with several Euro member sovereign debt are real and they are serious. If the debt is not handled in a real and serious manner, banking collapses will cause worldwide economic pain.
With demand finally chipping away at supply, crude, gas and diesel futures term structures are moving decisively from a contango market to a backwardation market. It is almost never wise to be short any commodity that is in contango, as products are coming out of storage and being sold decreasing forward supply.
Crude bears reading this may be screaming that the falling euro and strengthening US dollar is being left out of my 2011 forecast. And the bears are likely to be correct in this currency trend continuing in 2011. The stronger US dollar will help to alleviate a quick rise in crude to $149. However, 2011 is likely to be a year that breaks past correlations, with equities, commodities and the US dollar all rising together. Remember, currencies are driven by interest rates. US interest rates are on the rise.
In 2011 we may see crude gain 10% to 15%. Should the market give up some ground, traders should take advantage and add to long positions knowing the Chinese put is in place.
Happy New Year everyone!
For energy traders the key to future prices heavily rests on future demand. Since the US and China are the two largest energy consumers, an investor's energy demand forecast for these two countries, will largely dictate the proper trade.
China is imposing higher reserve requirement and higher interest costs for banks to slow down growth. The Chinese government will likely be successful slowing growth. Still, they will likely continue to see GDP growth at 8% or better in 2011.
One other important factor in China's crude consumption overlooked by many is China's desire to build greater emergency reserve capacity. I like to call this factor the Chinese put. When crude prices dipped down into the $70's handle last summer, crude tanker shipments into China increased. Why? China has become an astute energy trader. They were busy buying up all available crude at cheaper prices and placing the barrels into emergency storage. They will repeat this exercise on any major market downturn, effectively giving long traders a free stop loss put.
With all the talk about China, the United States is still the number one consumer of crude, gas and diesel. Should the US fall back into another recession this year, energy prices will be affected dramatically. Unlikely as this might be to happen, traders will need to keep monitoring events in Europe that would have the potential to derail the US recovery. The problems with several Euro member sovereign debt are real and they are serious. If the debt is not handled in a real and serious manner, banking collapses will cause worldwide economic pain.
With demand finally chipping away at supply, crude, gas and diesel futures term structures are moving decisively from a contango market to a backwardation market. It is almost never wise to be short any commodity that is in contango, as products are coming out of storage and being sold decreasing forward supply.
Crude bears reading this may be screaming that the falling euro and strengthening US dollar is being left out of my 2011 forecast. And the bears are likely to be correct in this currency trend continuing in 2011. The stronger US dollar will help to alleviate a quick rise in crude to $149. However, 2011 is likely to be a year that breaks past correlations, with equities, commodities and the US dollar all rising together. Remember, currencies are driven by interest rates. US interest rates are on the rise.
In 2011 we may see crude gain 10% to 15%. Should the market give up some ground, traders should take advantage and add to long positions knowing the Chinese put is in place.
Happy New Year everyone!
Saturday, December 18, 2010
Mexico Hedging and Energy Option Selling
Last week the Mexican government announced it had spent $800 million dollars buying crude puts in the $63 to $65 range. When triple digit crude prices appear to be on the doorstep, why did they place this hedge? The simple answer is that they are protecting their fiscal budget.
This is the proper and good use of hedging. Not to make additional profit, but to ensure an already budgeted profit.
Energy traders with a conservative risk tolerance should take heed of this action and look for opportunities to be sellers of put options, as there will be plenty of market participants similar to the Mexican government looking to buy options.
Although we may continue to see more pull back in energy futures as December winds down, especially with refiners looking to sell inventories to avoid ad valor em taxes and traders locking in year end profits. The outlook for 2011 is for energy to be well supported on any pullbacks allowing put option sellers to enjoy a profitable premium income stream.
This is the proper and good use of hedging. Not to make additional profit, but to ensure an already budgeted profit.
Energy traders with a conservative risk tolerance should take heed of this action and look for opportunities to be sellers of put options, as there will be plenty of market participants similar to the Mexican government looking to buy options.
Although we may continue to see more pull back in energy futures as December winds down, especially with refiners looking to sell inventories to avoid ad valor em taxes and traders locking in year end profits. The outlook for 2011 is for energy to be well supported on any pullbacks allowing put option sellers to enjoy a profitable premium income stream.
Sunday, December 12, 2010
The IEA and 78.6% Fibonacci
For the past several weeks the news has all been energy positive with big houses and OPEC raising energy demand forecasts for 2011. The International Energy Association (IEA), however, casts a different light on their forecast. Traders will do well to take heed.
The IEA released a tempered outlook for energy demand in 2011. They are foreseeing slower growth in China leading to a lower demand. Crude prices are being pegged to a range of $75 to $85. A sharp contrast to OPEC's $85 to $95 range. And even larger contrast to Goldman Sach's 2011 average price of $105.
The hope of a US economic recovery along with the Fed pumping the US economy with liquidity through a $600 billion bond purchasing strategy, has given traders the green light to add to long positions, driving crude past $90.
This has allowed traders to retrace the ever important 78.6% retracement level. A technical pull back is likely off this closely watched Fibonacci number. However, ultimately traders will need to heed any interest rate hikes coming out of China that will slow their economy and ultimately energy demand.
The IEA released a tempered outlook for energy demand in 2011. They are foreseeing slower growth in China leading to a lower demand. Crude prices are being pegged to a range of $75 to $85. A sharp contrast to OPEC's $85 to $95 range. And even larger contrast to Goldman Sach's 2011 average price of $105.
The hope of a US economic recovery along with the Fed pumping the US economy with liquidity through a $600 billion bond purchasing strategy, has given traders the green light to add to long positions, driving crude past $90.
This has allowed traders to retrace the ever important 78.6% retracement level. A technical pull back is likely off this closely watched Fibonacci number. However, ultimately traders will need to heed any interest rate hikes coming out of China that will slow their economy and ultimately energy demand.
Saturday, November 13, 2010
Catching the Elliot Wave
R.N. Elliott masterfully combined security price movements with human sentiments to come up with a technical charting technique now known as the Elliott Wave Principle. His thesis is simple. Prices react not only to supply and demand fundamentals, but also to greed and fear psyche.
There must be more than a few high volume crude traders following the Elliott Wave patterns this year, as text book waves are clearly marking crude's price direction.
Elliott Wave theory likens price movements to ocean tidal patterns. Price movement flows are charted in 5 low and high tide ebbing patterns. Pretty cool. The problem is that in the short term this writer has not been accurately able to see the beginning and end of each wave. However, longer term the picture evolves more slowly and clearly. And thus more useful for trading setups.
This week crude peaked at high tide wave B at $88.8 (78.6% retracement) and consistently withdrew or ebbed off high tide wave B. This sets up a larger out going tide C move lower. $85 is a key congestion support area going back to May 2010. A break below support brings crude down to lower $80's.
House traders will be carefully monitoring this out going C wave tide to try and hop on the low tide and ride it up shore on wave D. Told you this was cool stuff.
Last week the news was full of stories on higher crude prices. These stories are likely to be true in the longer run, but for now crude appears to be obeying R.N. Elliott's Wave thesis for a bit of a pullback.
There must be more than a few high volume crude traders following the Elliott Wave patterns this year, as text book waves are clearly marking crude's price direction.
Elliott Wave theory likens price movements to ocean tidal patterns. Price movement flows are charted in 5 low and high tide ebbing patterns. Pretty cool. The problem is that in the short term this writer has not been accurately able to see the beginning and end of each wave. However, longer term the picture evolves more slowly and clearly. And thus more useful for trading setups.
This week crude peaked at high tide wave B at $88.8 (78.6% retracement) and consistently withdrew or ebbed off high tide wave B. This sets up a larger out going tide C move lower. $85 is a key congestion support area going back to May 2010. A break below support brings crude down to lower $80's.
House traders will be carefully monitoring this out going C wave tide to try and hop on the low tide and ride it up shore on wave D. Told you this was cool stuff.
Last week the news was full of stories on higher crude prices. These stories are likely to be true in the longer run, but for now crude appears to be obeying R.N. Elliott's Wave thesis for a bit of a pullback.
Saturday, November 6, 2010
Ethanol and the Divided US Congress
Ethanol as an energy source has always needed government subsidies to exist in the marketplace. Now that Republicans control the House of Representatives, some major ethanol tax breaks for producers and blenders may go away for good in 2011.
In the long run doing away with the ethanol tax benefits will be a good thing. Using our food supply to run our vehicles was never a wise use of limited resources. And hopefully more research will be devoted to more productive and cost efficient alternative energy sources.
Will the recent increase in allowable ethanol blending formula to 15% have any affect on helping the ethanol production industry stave off imminent layoffs? Not anytime soon. Vehicle warranties are voided if gasoline is used with more than a 10% ethanol blend. So until vehicles adapt to the higher blends, gasoline marketers will not take the chance on selling 15% ethanol blended gas until they are comfortable law suits will not follow this new product.
With an expected decrease in US corn harvest, falling US dollar, and slowly rising US fuel demand, ethanol is likely to hold spot price support and according to Morgan Stanley, will average $2.59 per gallon next year. Ethanol like all other commodities will likely continue on the bid supported by the $600 billion Fed bond purchasing.
In the long run doing away with the ethanol tax benefits will be a good thing. Using our food supply to run our vehicles was never a wise use of limited resources. And hopefully more research will be devoted to more productive and cost efficient alternative energy sources.
Will the recent increase in allowable ethanol blending formula to 15% have any affect on helping the ethanol production industry stave off imminent layoffs? Not anytime soon. Vehicle warranties are voided if gasoline is used with more than a 10% ethanol blend. So until vehicles adapt to the higher blends, gasoline marketers will not take the chance on selling 15% ethanol blended gas until they are comfortable law suits will not follow this new product.
With an expected decrease in US corn harvest, falling US dollar, and slowly rising US fuel demand, ethanol is likely to hold spot price support and according to Morgan Stanley, will average $2.59 per gallon next year. Ethanol like all other commodities will likely continue on the bid supported by the $600 billion Fed bond purchasing.
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