A massive rally in the oil market starting last Friday has everyone asking whether oil has bottomed. I'm not sure that's the right question. Rather than finding an absolute low, I think this rally does a good job in setting the boundaries of oil trade for the next several months.
Everyone in the industry knows that virtually any oil price underneath $70 a barrel puts oil in an unsustainable range,. That is because there is plenty of oil, at least eight million barrels a day, that doesn't come out of the ground that cheaply. But does that mean that oil has to rally? Hardly.
Too many fundamental and financial factors still sit on top of this market, keeping a lid on oil finding its 'correct' price level. I've posited that oil won't find that level until at least two or three of these pressures are relieved.
One of these pressures is the continuing production glut here in the U.S. Another big increase in stockpiles on Wednesday stopped the oil rally, at least temporarily.
As for finding the lows of this market, before this rally some very wild numbers were being thrown around as to the absolute lows. I had heard some fairly intelligent analysts predicting $30 or even $25 a barrel. I think that this rally puts an end to the silliest of these bottom calls. We know oil is 'dumbly' priced here, but the market is at least beginning to put a limit on stupid.
Alternately, how high can it go? Again, I believe that the entire 'point' of this oil collapse has been to reorganize the oil world. That is particularly true in the U.S., where scalable shale reserves need to become the new 'swing' barrels into the global market. That is the position where the Organization of Petroleum Exporting Countries, and mostly Saudi barrels were previously.
That means that production has to come ultimately off-line here in the U.S. Right now, all indications are for the opposite -- increasing numbers for at least months to come. If, for example, oil prices were to rally high enough for U.S. marginal exploration and production players to hedge out future production and continue pumping, nothing in essence changes in the supply dynamic -- nothing.
I am convinced that while there are speculative buyers in oil here in the $40's because the number itself is so ridiculously low, I also believe there are real commercial sellers from marginal E&P's if oil should get near $60. And there are a lot of them.
Between these extremes are the boundaries where I think oil will likely trade for the next several months. Volatility , however, continues to be high inside these edges. If we get a weakening move in the dollar, as we did early this week and oil will soar.
Get another stockpile increase or another viciously bad Chinese economic report, as we did with the China PMI number, and oil will drop again. With oil moving freely, there are lots of traders trying to make money on the moves, helping to increase volatility too.
My best trading advice is to find your favorite E&P and wait for these limits to show themselves. Some of the boundaries on these stocks are making themselves pretty evident too, and you'll need to trade around those. I've successfully used Anadarko (APC), Cimarex (XEC) and even Oasis Resources (OAS) shares for this.