The West Texas Intermediate (WTI) crude oil contract is trading above $50 for the first time since February 2020, shaking off the last vestiges of the COVID-19 pandemic. Of course, the virus is still with us, but like the equity markets, crude oil has a discounting mechanism that predicts conditions six or more months into the future. That future looks bright right now, with vaccines rounding the planet and business activity expected to surge in the second half of the year.
- WTI crude oil just traded above $50 for the first time since February 2000.
- The long-term downtrend is still in effect, predicting that the rally will end near the $60 level.
- Energy stocks are lagging the futures contract by a wide margin.
- Climate change policy will likely put a lid on crude oil and energy stocks throughout the decade.
Even so, the contract has carved a string of lower highs since 2011, and the rally needs to reach the January 2000 high at $62.15 to set the stage for a new uptrend. That could be harder than it looks if the Senate goes 50-50, effectively allowing Democrats to pursue more aggressive climate change legislation. It's also possible that the party will resurrect the fossil fuel blame game that characterized Democratic debates in 2019 and 2020.
The contract has now rallied nearly 100 points since crude oil plunged into negative numbers in April 2020, posting a historic but short-lived low at -$40.32. That's not likely to happen again in our lifetimes because the complexity of contract expiration and rollover triggered the event, rather than supply or demand imbalances. Even so, it illustrated what can happen in the futures market when natural events drift to the extremes of the bell curve.
Unfortunately for energy bulls, the rally is having a limited effect on energy stocks, which are still trading at much lower levels. For example, the SPDR Select Sector Energy ETF (XLE) remains well below the June swing high, while the contract mounted a similar barrier in November. The downtrend in place prior to the pandemic is also exerting control, reflecting the growing impact of climate change policy and the switch to alternative energy sources.
A discounting mechanism operates on the premise that the stock market essentially discounts, or takes into consideration, all available information including present and potential future events. When unexpected developments occur, the market discounts this new information very rapidly. The Efficient Market Hypothesis (EMH) is based on the hypothesis that the stock market is a very efficient discounting mechanism.
Crude Oil Long-Term Chart (2000 – 2021)
Crude oil took off in a powerful uptrend in 2004, entering a parabolic phase at the start of 2007. It posted an all-time high at $147.27 in June 2008 and plunged during the economic collapse, dropping all the way back to 2003 price levels. The contract turned higher into the new decade, posting lower highs in 2011, 2013, and 2014. It dropped like a rock into the first quarter of 2016, finding support at the 2008 low.
A modest uptick reached the trendline formed by 2008, 2013, and 2014 highs in October 2018 and reversed, completed the final stage of a massive descending triangle that broke during the pandemic. The second quarter bounce triggered a "failure-of-a-failure" buying signal, presaging strong price action through the rest of 2020. However, the trendline still marks a formidable barrier, predicting that the rally will end at or near $60, posting the next lower high in the unbroken 10-year string.
The monthly stochastic oscillator is about to hit the most extreme overbought technical reading since 1999. Price action is approaching heavy resistance at the 50- and 200-month exponential moving averages (EMAs) at the same time, adding reliability to the bearish power of the massive trendline. The most likely outcome in this scenario: the contract eventually settles around the $50 level and trades within relatively narrow boundaries well into the decade.
A descending triangle is a bearish chart pattern used in technical analysis that is created by drawing one trendline that connects a series of lower highs and a second horizontal trendline that connects a series of lows. Oftentimes, traders watch for a move below the lower support trendline because it suggests that the downward momentum is building and a breakdown is imminent.
The Bottom Line
Crude oil is trading above $50 for the first time in 10 months, but additional upside potential appears limited.
Disclosure: The author held no positions in the aforementioned securities or their derivatives at the time of publication.