West Texas Intermediate oil futures briefly crossed above $50 per barrel today, and those of us who follow the crude realities of oil pricing are trying to divine whether this is yet another head-fake or if we are headed to $60/barrel. Except for a few days in late-May 2015, WTI prices haven't stabilized above $60/barrel since the disastrous OPEC meeting on Thanksgiving 2014. So, while today's move through the $50 mark was short-lived -- the futures closed at $49.89 --$50 is an important psychological threshold. Even more importantly, Brent futures broke through -- and held -- the $55/barrel mark. Supply disruptions explain the widening spread between Brent and WTI, but it is optimism on demand that has driven the rally in oil futures around the globe this week.
The International Energy Agency yesterday raised its forecast for oil demand growth in 2017. The IEA's forecast now sits at 1.6 million barrels per day of growth and September's estimate is the third consecutive monthly increase in the IEA's estimate, As recently as June, the IEA was estimating only 1.3 million barrels of daily growth in oil demand for 2017.
It is very easy to get lulled into a constantly shifting paradigm in the oil market by following the deluge of weekly and monthly data. We're almost three years removed from $60/barrel crude so the question remains: why should this move be the range-breaker, the beginning of a breakout as opposed to a false flag?
A clue comes from the CBOE's oil volatility index, OVX. The counterpart to the S&P 500's (VIX.X) index, OVX has been depressed of late, dropping to 26.09 today after hovering in the low-30s for much of August. That tells me that oil traders are being lulled into the same sense of complacency that has gripped the equity markets for all of 2017.
According to the CBOE's website:
"The OVX, or "Oil VIX," measures the market's expectation of 30-day volatility of crude oil prices by applying the well-known CBOE Volatility Index (VIX) methodology to options on the United States Oil Fund, LP (ticker symbol (USO) ), spanning a wide range of strike prices."
The fact that OVX measures the implied volatility in contracts of options linked to USO, not underlying movement in crude futures themselves, may seem like an important distinction, but it really is not. A very small proportion of WTI contracts ever reach the point of engagement, i.e. physical delivery of barrels to the storage point in Cushing, Oklahoma, and Brent futures are purely paper instruments; physical delivery is not possible.
So oil markets are always a sea of paper that represents the clearing price for the commodity futures, not the actual real-time value of a barrel of oil. Paper moves can be magnified by market sentiment much more than could an actual barrel of oil, given its heaviness (42 gallons) and need to be produced in bulk.
If traders are less bearish, it stands to reason that OVX will fall and crude prices could finally rise. I think that's what the oil markets are telling us, and I am looking to get long E&P stocks and some of the highly-volatile leveraged commodity ETFs (ProShares Ultra Bloomberg Crude Oil ETF (UCO) , for instance) going into the fourth quarter. I'll have individual stock recommendations in my column tomorrow, and If I'm right about an oil breakout, it would be a portfolio-transforming event.