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The Bottom In Oil


Political events in the Middle East are moving the Saudi/Gulf way.

I believe there is an agreement to patch things up.

This will lessen the Saudi/Gulf need to use the oil weapon.

Back on December 14, I wrote on by blog The Commodity Strategist:

“It is unrealistic to think that the Saudis and their Gulf allies will give on output without getting something in return. Since it is highly unlikely that the other OPEC members will cut output, this “something” has to be political. It will be tied up with the battles raging in the mideast. When it looks like there may be progress on those, we can start thinking about a firming of oil prices.”

That time is now. The politics in the Middle East are breaking the Saudis’ way, and I believe understandings have been made.

  • Iran has substantially cut back their support of the Houthis in Yemen. Apparently, they are resigned to let the old Saudi-friendly regime retake control. It’s possible that they simply are facing up to the reality that they could not win, but some kind of understanding is also possible.
  • A potent anti-ISIS coalition has been formed in Iraq and is forming in Syria. The Iraqi army, the Iranians, the Russians and the US are on the same side and are coordinating their efforts. This is already getting results in Iraq.
  • Turkey looks like it may be getting on board via closing its border with Syria. If so, there will soon be progress in Syria as well.
  • The recent resolution of the UN Security Council on the issue is important. Not because the UN can or will do anything, it cannot. But it shows that the major geopolitical players are united on the importance of settling the issue. This is real politics, not symbolism.

So I believe we are at or near (in terms of time) of a bottom in oil. How to play this? I am trading oil futures from the long side. My idea is that there will be a good two-way market for awhile with an upward bias. This is buy the dip tactics. Here are some other ideas for readers who are not active traders.

  • Do not buy the usual ETFs like the United States Oil ETF (NYSEARCA:USO) or the iPath S&P Crude Oil Total Return Index ETN (NYSEARCA:OIL). The contango will kill you. Instead, open a futures account and buy a deferred contract. December 2016 or even December 2017 are the cleanest ways to play this.
  • The equities of E&P companies would also be good. You should be aware, however, that these companies are already trading with implied oil prices that are higher than the current strip. So if oil just stays where it is, they could be in serious trouble.
  • I would still stay away from natural gas producers. Although NG may get a bounce when the weather turns, there is an ocean of LNG lapping at the shores of the market. This is very bearish for international prices. See my blog post of December 14 for a little more color.
  • The key risk here is that we run out of storage, and the spot price collapses further. If this happens, I do not believe the one- or two-year forwards will fall too much. They will be dominated by longer term considerations. Nonetheless, they will fall. Either keep this in mind when sizing your position or use appropriate money management techniques.

And finally, don’t trade with money you can’t afford to lose! This trade is my opinion only, and I have been known to be wrong before.

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