Oil, War and Inflation: Here's Where Prices Are Likely Headed

The oil market is difficult to predict in a conventional environment and is impossible to predict during a war. At the moment, there are two significant wars taking place: one between Russia and Ukraine and one between global central banks and inflation. The result of the political and economic turmoil has been an unprecedented amount of energy market volatility and shocking moments of illiquidity as traders react to tight energy supplies and attempt to hedge inflation. The West Texas Intermediate light sweet crude oil futures contract traded on the New York Mercantile Exchange division of the CME Group is considered the world's benchmark measure of oil price. It is also generally the most viscus energy futures market in the world. Yet, in recent months many veteran market participants, including myself, have referred to the market as broken. During normally functioning markets, the spread between the bid price and the ask price (the price you can sell at and the price you can buy at) is a penny or two, but there were times during the overnight session this spread was near a dollar! Further, even during the most liquid times of the day session, we were seeing spreads of a dime or more. This, along with erratic price changes is a sure sign of dysfunction. The first chart, below, tells a similar story of disorder; a year's worth of price movement and multiple bull and bear markets as measured by 20% moves was occurring in single trading sessions in early March. While the volatility has moderately decreased since it is still at historically unruly levels. When Russia invaded Ukraine, it caused the price of WTI crude oil to break above trendline resistance and deviated prices from what had been a well-defined expanding wedge pattern. Had war not broken out, we believe prices would have continued to trade sideways to higher within that trading wedge. Since the Russian invasion, prices have managed to mostly hold above this trendline despite a few temporary probes back into the trading wedge. At the moment, $102.00 appears to be the price that, if broken, would push prices back into the trading wedge and could even lead to mass liquidation into the $70s. The weekly RSI is currently pointing higher but is nearing overbought levels. The bulls have an edge in the short-run but in the long run, we believe demand destruction will lead prices back into what might have been the trading range had the war not broken out. View Chart » View in New Window » Chart Source: QST From a bigger picture perspective, we categorize the last 20 years of oil market pricing as pre-fracking and post-fracking. U.S. shale production after the advent of fracking was a game-changer in the oil market; since its introduction to the industry, oil prices have mostly remained under price pressure. That has changed in recent years due to societal and political pressures to go green. Further, reluctance for banks to finance the energy industry and supply-chain woes have also worked against robust production in the U.S. Nevertheless, the reality is that fracking technology exists and will eventually come into play again. According to Baker Hughes, the U.S. oil rig count is approaching 600, a two-year high. Chart Source: TradingEconomics.com On a monthly chart, we can draw a fracking pivot line that suggests prices could be rejected near $120.00 if tested. We did see the front-month oil future surpass this area in the heat of the moment in early March, but it failed to close above it. We suspect the second attempt will fall short of the March highs (and be contained by $120.00). Further, the 2011 oil high was roughly $115.00, which is also a technical headwind for the current rally. The monthly RSI is in the mid-70's, suggesting prices are extended and vulnerable to swift selling if traders are given a reason to reverse course. View Chart » View in New Window » Chart Source: QST Narrowing in on the daily chart, we can see prices have recently broken out of a long and drawn-out triangle pattern. While we agree prices could press higher in the short run, we believe the market will eventually shift focus from supply issues to the demand side of the equation; this, and chart resistance between $115.00 and $120.00 should keep the bulls on their toes. Oil rallies can be swift but selloffs can be just as stunning. View Chart » View in New Window » Chart Source: QST

Oil, War and Inflation: Here's Where Prices Are Likely Headed

Oil has a war and inflation hedge premium, but those aren't permanent.

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