Home / Energy / OIL: Looking for the Bottom Part 2
Oil

OIL: Looking for the Bottom Part 2

In Part 1 of OIL: Looking for the Bottom, we covered two important metrics for identifying when the bottom is in- Credit Bids in bankruptcies, and Bureau of Land Management (BLM) leasing reports. I consider those two the most useful of fundamentals metrics. But there are other issues to watch for confirmation of those findings.

M&As

Let’s start with mergers and acquisitions (M&As). Watch the nature and size of oil/gas M&As. The analysis isn’t as straightforward as Credit Bids, but can give important clues to when a bottom has been reached. Spotting the hand of Big Oil in M&As isn’t always easy, as they can cloak activity behind a dense wall of cutout companies. But you can easily spot sharp upticks in deal sizes just by scanning article headlines from day to day someplace like OilandGas360. Another good starting point is Oil & Gas Financial Journal. One important caveat, though, and I’m not accusing anyplace in particular here, but keep in mind that media hype can give a false picture. So screaming headlines like “M&As on the Rise!” should give rise to caution.

Storage

Like every other metric in this hunt for the bottom, storage levels don’t tell the whole story but can serve as a clue. Oil storage levels at Cushing, OK are watched closely worldwide. In addition to many other report types, the U.S. Energy Information Administration (EIA) puts out monthly reports on Cushing storage levels, as well as weekly qualitative estimates. But this data is largely based on voluntary reporting by Cushing participants. A better approach may be to either subscribe to a service like Genscape’s or use an oil ticker like WTI as a proxy and examine price trends across several weeks on certain days and at certain times of day (explained below).

A key Genscape report comes out at 10 a.m. ET on Mondays and Thursdays; the Monday report leads the comparable EIA report by two days (EIA reports on Wednesdays). While the EIA report is only an estimate, Genscape data is mainly generated by helicopter overflights of the Cushing area, using infrared imaging and other technology to see how much the tanks actually have. Genscape has charts comparing its reporting to EIA reporting (see them here) and they show an uncanny accuracy.

Again, you can pay to get such reports, but I think the average trader would be hard-pressed to interpret them with success. This is because the effects of peak storage and declining storage on price is a conundrum within a mystery, and I prefer to leave its unraveling to richer heads than mine. First, a maxed-out Cushing represents only about a three-day supply of oil. At max-out, one wonders what happens next. Do producers simply stop producing, forcing up prices? Or do they go on producing and the oil gets diverted into direct use, forcing prices further down? See what I mean?

So, from a quant perspective, I prefer to look at those key hours mentioned for some kind of trend in WTI, and compare that to rising or falling storage levels. In other words, I let the rich do the heavy lifting for me, since the smart money is reflected in WTI prices. If you use a TD Ameritrade Thinkorswim account- even a free demo version- you can load the code below and run it on an Hourly chart to easily see the Genscape effect (after loading, you’ll have to right-click on one of the dark-green bars and choose Use Left Axis to view it properly):

  • def OpenTime1 = SecondsTillTime(1000)<=0;

         def EndTime1 = SecondsTillTime(1100)<=0;

         addCloud(opentime1,endtime1,color.dark_green);

The above code will mark all 10 a.m. hours for you. Or, you can mark a Daily chart with Mondays and Thursdays this way:

  • declare hide_on_intraday;

         input day_of_week = {default Monday, Thursday};

         AddChartBubble(GetDayofWeek(GetYYYYMMDD()) == day_of_week + 1, high, “M”);

         AddChartBubble(GetDayofWeek(GetYYYYMMDD()) == day_of_week + 4, high, “TH”);

Better yet, run both codes and view them on an Hourly chart- this will show you which 10 a.m. hours belong to Mondays and which to Thursdays.

The effects on price of the Genscape reports are quite striking and, with a little analysis, can even be used for swing trading, but as yet I don’t see evidence for a serious bottom.

Oil2Bottom 1

Oil2Bottom2

Seasonal Effects

When looking for the real oil bottom there are traps out there and seasonal effects are a big one. They can give a false impression of durable price movement in either direction.

Many of us, if asked, will say that oil and natural gas prices go up in winter and down in summer. It just ain’t so (gasoline is a special case, where price does tend to go up in summer months due to increased travel). Our mistake is that we’re using demand-side economics to anticipate supply-side demand and, as they say in Vermont, you can’t get there from here. We’re saying to ourselves that since people use more oil and natural gas in winter to stay warm, price should go up. We also completely forget that natural gas and oil are used to drive turbines to produce electricity, and electricity is what drives air conditioners in summer. But there’s an even bigger fallacy in our thinking: We’re assuming a simple equation with the end consumer on one side and the supplier on the other.

But the way it really works is that the end consumer is only one of the consumers in this situation. The other main consumer is Big Storage, whose demand is what really controls price. They’re the wail that tags the dog. In early spring and early fall, Big Storage starts buying oil and gas in anticipation of supplying it to the retailers who in turn deliver energy to the end consumer for cooling and heating needs. These periods are known as injection seasons. So, price tends to peak around April and October. Thus, you may think you see oil in liftoff mode this month (April 2016), only to be disappointed by June.

The watchword for using oil and gas prices per se is caution. Wait’ ’til sometime when it’s not injection season to do technical and quant interpretations. For example, if this March-April WTI spike holds into June, we could very well be off the bottom at last (though I personally don’t expect that). On the other hand, if we see more decline by June, I’d go short.

Also, if you’re looking to play the contango card, beware. Contango is the idea that futures prices (called ‘strip prices’, which is a ‘strip’ of near-term prices) are higher than distant futures prices. You therefore buy a futures contract now (to store your oil), take delivery months later, and sell the oil for a tidy profit. Most analysts believe that a safe contango spread for doing this is a minimum of $10-12 per barrel. But remember our Cushing discussion? Right now, the place is almost maxed out. So storage costs could do real harm to that futures contract of yours, right? Ditto the backwardation card, in case you’re a shorter: some unforeseen set of events could wipe out Cushing stores in just three days, making storage cheaper and driving that futures contract you sold through the roof. For the curious, this StockCharts page explains in detail, with chart examples. Wait and watch- May and June.

Index Tea Leaves

Now here’s a Monthly chart that should warm the heart of any devout shorter. It’s EPX(NASD), the SIG Oil Exploration & Production Index. It’s a basket thing of 21 companies that either own, lease, or operate oil or natural gas facilities. Based on this, even a novice technician would say, at a glance, that we have awhile to wait for the bottom of oil. A long while. But, hey- markets are crazy, so you have to weigh this metric against all the others because anything can happen. Still, it’s one of the ugliest charts I’ve ever seen.

Oil2Bottom3

Swing Trading Help

The chart algo below probably won’t help you find the bottom, except maybe on a Monthly or longer chart, but it’s great for helping with swing trading the ups and downs while you wait by trading Light Crude directly or using it as a proxy for another security. You could write your own algo for this (next paragraph) or the ThinkScript code for it is bundled in with the little tutorial at my site. You could then run the code, even in a free demo account on TD Ameritrade’s Thinkorswim platform.

If you want to write your own algo, in MQL or EasyLang or ThinkScript, I give you here the narrative form of the OrangeQuant algorithm that generates the chart below. It’s elegantly simple: On FullStochastic, if you see FullD close down from its Close of the previous period AT THE SAME TIME as FullD is greater than FullK AND AT THE SAME TIME as FullK closes down from its Close of the previous period, then you very likely have a SHORT opportunity; CONVERSELY, if you see FullD close up from its Close of the previous period AT THE SAME TIME as FullD is less than FullK AND AT THE SAME TIME as FullK closes up from its Close of the previous period, then you very likely have a LONG opportunity. Code it so the SHORT signal changes the price bar to one color and the LONG signal changes it to a different color, as you see in the chart.

Oil2Bottom4

Green and Magenta are signal bars. A key advantage, besides the code changing the price bar’s normal color, is that it often catches a signal too small for the eye to be sure of when looking at FullStochastic. Above is a Weekly chart but it also works on Monthly, Daily, Hourly, and even 10-min, though somewhat better on the longer TFs, in my opinion- or maybe I’m just looking at the gain ranges.

Part 3 of Oil: Looking for the Bottom, the last in this series, will take a look at a few more elements of the oil puzzle and certain wildcards which may have escaped your notice.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of FinancialPress.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://financialpress.com/legal-disclaimer/.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of FinancialPress.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://financialpress.com/legal-disclaimer/.

Check Also

PC Magazine Features Vuzix’s Award-Winning “No-Nonsense” Smart Glasses

Positive Review Highlights Vuzix’s Advancements in Both Style and Functionality In an article entitled “Hands …

Leave a Reply

Your email address will not be published. Required fields are marked *