2015 will go down in history as one of the worst years in global commodities market. This year alone, the Bloomberg Commodities Index (BCI) which tracks the world’s major commodities has fallen by more than 40%. This has led to significant losses in all the major oil and gas companies, indices, and ETFs. As a result, oil longs have suffered massive losses. For day traders, these movements in prices have become a goldmine. This is simply because day traders are able to allocate their capital either by going long or short over a short duration of time. This trend is expected to continue in the next year.
How oil is priced.
Oil is a commodity. This means that the price of oil is determined by the prevailing market conditions. Supply and demand are the key determinants of oil prices. When the supply of a commodity exceeds the demand, the result is that the price will go down. This is simply because people have various options of buying. Since oil is a rare commodity, only a few countries are able to produce and supply it in the required numbers.
In oil exporting, there are usually two groups of exporters. There are those groups belonging to the Organization of Petroleum Exporting Countries (OPEC) and those which do not belong to this group. OPEC members are: Saudi Arabia, Angola, Ecuador, Nigeria, Qatar, Venezuela, United Arab Emirates, Libya, Iran, and Iraq. These countries produce more than 30% of all the oil in the world. For the non-OPEC members, the largest producers of oil include: China, United States, and Russia among others.
In 2014, OPEC member countries (also known as the oil cartel) met in Vienna for their annual general meeting. During this time, they decided that the biggest threat to their oil business was the United States where fracking is a new concept of oil extraction. Fracking is one of the most expensive methods of extracting oil. Therefore, by increasing oil production, OPEC members believed that they would indirectly shut business for the fracking companies. Therefore, they started the process of oil oversupply thus leading to the fall of oil prices. In 2015 alone, crude has fallen from $100 to the current $39.
Risks and opportunities ahead
For oil traders, the future looks great. This week, the oil cartel held their annual meeting in Vienna where they were expected to report reduction of oil supply. Many countries such as Venezuela and Kuwait have really suffered from declined oil prices and were expected to oppose any measures of status quo. The meeting, held on 4th December was tense with many countries looking forward to a cut in supply. This was further heightened by the words of Saudi Arabia energy minister who was earlier quoted saying that his country would work with other members to make the oil prices stable. Unfortunately (or fortunately for some), the meeting decided to leave the oil supplies unchanged. Oil prices which were on an intraday bull run suddenly fell. Crude oil dipped to $39 a barrel and Brent oil fell from $44.43 to $42.54 a barrel.
For day traders, these instances present a sweet opportunity that cannot be overlooked. With supply unchanged, the impending interest rate hike by the Federal Reserve, and the continued slowdown in the global economy, oil prices are expected to remain low.
Iran, Federal Reserve, and China
These three aspects are the most important for any trader to watch going forward. Iran, which has for long been sanctioned by major countries is expected to resume exporting of oil in June 2016 after the atomic agency of the United Nations clears the country as a safe one. This follows the Iran nuclear deal which was signed in July this year. Their re-entry will lead to increased supply thus compressing the oil prices. Secondly, the Federal Reserve is expected to start hiking interest rates in December this year. Oil prices are quoted in dollar terms. Therefore, a strengthening dollar will lead to significant losses in oil. While China’s growth is still on course, the fact is that the country is slowing at a slower level. As the biggest consumer of oil, this will not be to oil’s advantage.
With all these factors compounded, oil prices are likely to remain lower. I suspect an instance where crude oil prices falls to the mid-30s before the next OPEC meeting in June. For traders, this will be an amazing opportunity in many ways. One can short oil as a commodity. Alternatively, one can short oil stocks especially American firms that do fracking.