It seems like everyone's got an opinion on oil these days. Some people think oil is heading to $40 while others are of the opinion that the sell-off has been too harsh and prices should rebound rapidly. Sorry to disappoint but I don't fall into either camp. Here are my thoughts on crude oil in no particular order:

  • Crude oil is oversold but the decline has been too orderly to make it an attractive "knife catching" setup
  • The shallowness of the bounces indicates that sellers have been aggressive in liquidating into rallies, regardless of how small the rallies have been
  • The Saudis knew what they were doing when they refused to cut production at the last OPEC meeting, they intend to inflict damage on higher cost North American crude production. This probably means that oil prices have to be at or below $60/barrel for a couple of months in order to leave a lasting psychological impact upon the market that Saudi still rules the global oil market.
  • A couple of things pop out at me on the monthly chart of West Texas Intermediate Crude Oil: 1. crude fell below its 200-month simple moving average today for the first time since February 2009 2. There is a lot of price memory in the $50s dating back to the 2004-2006 time frame:

WTI_Monthly

  • At $50/barrel there isn't a single US shale oil play that is profitable. This fact combined with the above chart leads me to believe that $50 is roughly the downside limit for crude.

US_shale_breakevens

I envision a scenario in which crude bottoms at some point in the next few weeks (in the low-to-mid $50s) and rebounds a bit (~20% rally) before settling into a range collared by $55 on the downside and $75 on the upside.

How will we know oil has bottomed? To quote Jeffrey Gundlach "Oil will find a bottom when it starts going up" and to be more specific, the first 20% rally since crude began crashing during the summer would be a good indication that a bottom has been put in place. Another good indication would be if the OVX (CBOE Crude Oil Volatility Index) broke back below the 38 level:

OVX