The Crude Truth: Oil Prices Unlikely to Rise Substantially in 2010

It sounds like an investors bad dream:  Hope for an improving economy continually stymied by negative economic reports and sovereign debt fears; A seemingly optimistic stock market giving way to reality;  Commodities prices that seem to be stuck in limbo; Everyone waiting for fall elections, eyeing government decisions on tax cuts and following dismal interest rates.

Not a great time to be an asset appreciation investor.  But for option sellers, it’s just what the doctor ordered.  Flat, balanced, status quo – those are often Profit words for sellers of premium.

It’s also a good way to describe Crude Oil prices these days, as crude is often a “quick glance” indicator of the state of the global economy.

US demand for crude should stay flat in the second half of 2010 – right along with the US economy.

Even if one considers the precipitous drop in prices from May, Crude oil remains stuck in a roughly $20 trading range. However, take out May’s “attitude adjustment” on the US economy, and the range narrows considerably. It appears that crude has settled into a comfortable trading range near where it’s true value should probably be.  By our analysis, there is a good chance it could stay there for awhile.

Headwinds for Prices

While it has never been our intention to attempt to pick market direction (option sellers don’t have to), you can increase your odds of success on option selling trades by doing an analysis of what factors could move prices higher or lower. And it appears at this time that there are more forces aligning to keep prices in check than there are to push them higher.

Most notably:

1. Demand should level off as the US economy finds itself bracing for a “slower rate of growth” in Q3 and Q4 of 2010. Despite this month’s headlines that China surpassed Japan as the world’s second largest economy, the US still dwarfs the Chinese in overall oil consumption.  That means the direction of the US economy is still one of the biggest factors in driving oil demand.  First time claims for unemployment benefits unexpectedly increased last week to 500,000, the highest since last November. Unemployment has been a stubborn thorn in the side to economy bulls and this latest figure is undoubtedly disturbing to them.  While the US still appears to be creeping along at a slow rate of growth led by indicators such as manufacturing, consumer spending is expected to slow again in the fall and winter.  Housing figures remain discouraging. Even the Federal Reserve is telling the public to expect a more “modest” rate of growth in the second half.  Slowing rates of growth do not typically boost energy demand. Remember that 2/3 of oil demand in the US comes from the industrial sector.
2. Supplies remain burdensome: Despite this week’s 818,000 barrel drop in crude oil stocks, EIA figures still show US inventories running about 8.2% over the five year average at 354 million barrels. BP may have made an oily mess of the Gulf. But there remains plenty of oil above ground in US facilities.

US Crude Oil Stocks remain burdensome at 8.2% over the 5 year average.

Flat demand and oversupply are typically not a solid recipe for bull markets.

The Counter Argument

However, before you start short selling crude oil with both fists, know this: We do not expect oil prices to fall out of bed. While in our opinion, the prospects of a new bull market remain unlikely, we see it equally unlikely that crude prices will decline precipitously.

The BRIC nations (Brazil, Russia, India, China) continue to experience solid rates of growth. The Chinese economy is expected to grow by another 10% this year. China has recently displaced Japan as the worlds second largest economy.

While expected to slow, US gasoline demand remains above 2009 levels. Year to date fuel consumption for 2010 is running at 0.9% over 2009.

Conclusion/Option Selling Strategy

There is nothing spectacular in anything you have read above. And that is exactly the point. “Regular” investors have to seek out the extreme; the markets with “potential”; the big movers.  For option sellers, range bound markets are your bread and butter. In commodities, that can mean some pretty wide ranges – and some good reasons for selling options.

Our expectation for Q3 2010 is for oil prices to remain in the $70-$80 range with a $5 margin for error on either side. This should work out just fine for investors wishing to bank some solid premium by strangling the crude oil market (selling puts far below the market and calls far above.) With calls now available in the $120 per barrel range and puts near the $50 range, we see opportunities for option selling investors this month.

Liberty Trading Clients are now positioning for the 3^rd and 4^th quarters of 2010. If you would like more information about having James Cordier manage your option selling account, feel free to give us a call at 800-346-1949 or request one of our Free Option Seller Information Packs at www.OptionSellers.com ($100,000 minimum investment).

James Cordier is the founder of Liberty Trading Group/OptionSellers.com, an investment firm specializing exclusively in selling commodities options. James’ market comments are published by several international financial publications and news services including The Wall Street Journal, Reuters World News, Forbes, Bloomberg Television News and CNBC.  Michael Gross is an analyst with Liberty Trading Group/OptionSellers.com. Mr. Cordier’s and Mr. Gross’ book, The Complete Guide to Option Selling 2^nd Edition (McGraw-Hill 2009) is available at bookstores and online retailers now.

*Fundamental Chart Courtesy of Hightower Research

** Price Chart Courtesy of CQG, Inc.

***The information in this article has been carefully compiled from sources believed to be reliable, but it’s accuracy is not guaranteed. Use it at your own risk. There is risk of loss in all trading. Past performance is not necessarily indicative of future results. Traders should read The Option Disclosure Statement before trading options and should understand the risks in option trading, including the fact that any time an option is sold, there is an unlimited risk of loss, and when an option is purchased, the entire premium is at risk. In addition, any time an option is purchased or sold, transaction costs including brokerage and exchange fees are at risk. No representation is made that any account is likely to achieve profits or losses similar to those shown, or in any amount. An account may experience different results depending on factors such as timing of trades and account size. Before trading, one should be aware that with the potential for profits, there is also potential for losses, which may be very large. All opinions expressed are current opinions and are subject to change without notice.