Oil is traded around the globe supplying most of the energy that is used for everything from transportation to electricity generation. Oil is generally considered a fungible asset. This means that oil with certain specifications should trade at the same level excluding transportation, in every location around the globe. There are several supply-and-demand dynamics that you can use to determine the future value of oil, which can be categories as fundamental analysis. Also, many oil traders use technical analysis to determine the future price of oil. You can also use a combination of fundamental and technical analysis to invest in crude oil.
What Has Occurred in 2020
The oil market has faced significant headwinds in 2020. The onset of COVID-19 has reduced demand world-wide. Total global oil demand could decline by more than 20-million barrels a day, which is currently baked into the price. Gasoline demand has tumbled as citizens across the globe are “sheltering in place”. The number of flights has been significantly reduced across the globe. In the New York area, some of the major airlines have cut the number of flights per day by 90%.
Cruises have also come to a halt, which has greatly reduced the residual fuel demand. Lastly, the cost of storage has surged. Storage costs can be evaluated by looking at the difference between consecutive oil futures contract months. The difference between the first and second WTI oil futures contracts is more than $6 per barrel. This is the cost to store oil in a CME regulated storage facility.
How to Evaluate Supply and Demand
There are several ways to determine supply and demand. One of the most popular is to evaluate the supply and demand for the largest global consumer, which is the United States. The supply, demand, and inventory levels are estimated weekly by the Energy Information Administration (EIA) which is part of the US Department of Energy. Each week the EIA provides estimates of inventory levels, including production, consumption, exports, and demand.
The production numbers tell you the volume in millions of barrels that are produced in the United States every day. The consumption levels are called products supplied. This is the total amount of products that are either consumed or exported. Key metrics that are often evaluated is the volume of inventory and how that inventory stacks up against inventory levels during the past 5-years.
The price of oil is generally a function of future supply and demand levels along with future inventory levels. These metrics are forecasted by energy analysts and then compared by traders to the actual releases that are reported by the EIA.
Using Technical Analysis
In addition to using fundamental analysis, many traders use technical analysis to evaluate the oil markets. Technical analysis is the study of past price movements. You can look at the history of price changes on a chart that your broker might provide. There are plenty of software programs that show historical prices. Traders often evaluate several different metrics. This includes using support and resistance, studies and patterns.
Support and Resistance
Support is a price level where prices find demand. This is a level where prices have a difficult time moving lower. You can evaluate support and resistance levels using trend lines, price highs, and lows and moving averages. For example, the downward slope of a trend line would be a place where the price cannot breach through. The price low in March might be a region where prices cannot slide lower. Support and resistance levels can help you enter or exit oil trades, as well as formulate risk management.
Another way to determine future movements is to follow a trend. A trend is a movement in prices that continues to perpetuate in one direction. One of the best moving average techniques is the moving average crossover strategy. This provides you with some insight into the current trend.
The chart shows the 50-day moving average crossing below the 200-day moving average which is known as the “death cross”. It generally signals that a long term downtrend is in place. If you are looking for the change in a short-term trend you might consider using the 5-day/20-day moving average crossover. A medium-term trend could be signaled by a 20 and 50-day moving average crossover.
You might also consider analyzing momentum. The MACD (moving average convergence divergence) index measures momentum by comparing two moving averages, that have different tenors. The MACD provides a crossover buy and sells signals that can be used to determine future price momentum.
The Bottom Line
The upshot is that there are many ways to evaluate the future price of oil. You can use fundamental analysis, focusing on supply and demand. You can use technical analysis, which allows you to forecast future prices using past price action. You can also use the combination of the two.