After spending most of the last three-and-a-half years moving higher, crude oil prices finally came back to earth, losing nearly 30% of their value in little more than a month. That decline may or may not be over, but it’s taking a breather as the market enters a crucial period.
Crude oil futures finally hit the pause button on selling this week, despite news that another week brought another record for crude oil production as drillers put more rigs into service. This bearish-report, bullish-reaction trade came along with more talk Saudi Arabia will lead OPEC and its allies to renewed production cut in 2019.
It was OPEC’s cuts in 2016 that finally turned the crude market higher, in response to the huge increase in U.S. production. Saudi Arabia convinced OPEC to raise production this summer to offset the Trump administration’s sanctions on Iran that had the industry buzzing about a return to $100 crude. But the administration ultimately granted waivers eight countries, including South Korea and India, allowing them to buy Iranian crude after the sanctions took hold earlier this month, putting more barrels on the market. A few timely tweets by President Trump complaining about high oil prices sent the market over a cliff.
OPEC holds its next formal meeting Dec. 6, though ministers talked about cuts at their meeting earlier this month. The uncertainty in the market about what happens next is highlighted by a return of high volatility to the crude oil options trade. Volatility traded over 40% this week. With my models showing crude fairly valued around $63 a barrel and trading today around $56, that means futures in theory could trade in a range from as low as $36 to as high as $90 in the coming year.
Lower OPEC production likely would rally the market again, but international politics could restrain members along with mere economics. World economic growth is slowing, decreasing crude oil demand, for one.
Farmers don’t buy crude oil, but they use what refineries turn it into – diesel. Cash wholesale Midwest fuel prices dropped around 40 cents off fall highs but didn’t experience the type of funk that affected crude and gasoline, which plunged 33% from spring highs. While gasoline demand wanes after the peak summer driving season, usage of diesel rises as farmers burn through supplies at harvest. This year prices were also supported by deeper than usual production cuts as refineries shut down for maintenance. Midwest production is rising again, but inventories fell again last week. Basis for Midwest cash firmed against futures delivered in New York Harbor as a result.
Weaker basis into winter as demand drops and supplies build could offset at least some of any impact from higher crude prices, at least for a while. Winter weather also plays into the mixed since USLD is used as a heating fuel in parts of the Northeast. Based purely on supply and demand – and not the emotions of the market – cash wholesale benchmarks could drop near last winter’s lows near $1.86. The Group 3 and Chicago prices traded as low as $2.04 this week before firming.
Crude’s pullback hammered propane costs, extending the seasonal pullback normally seen after stocks build ahead of the winter heating season. Rising U.S. natural gas and oil production should keep propane output rising, and swaps long-term suggest lower prices. But propane also follows crude, so a larger rally in that market could affect prices for drying and heating fuels. The Conway, Kansas hub briefly traded below 60 cents a gallon this week, hitting levels I recommended for buy 2018 inventories. Use any move below 60 again to lock in 25% of 2019 needs if you can buy in increments.
Weakness in gasoline triggered a buildup in ethanol inventories and forced plants in areas with higher costs for corn to shut down. Production so far in the 2018 corn marketing year is down around 1% year-on-year. If that trend continues, only a surge in E15 demand in the summer of 2019 will keep corn usage close to USDA’s current estimate.
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Senior Editor Bryce Knorr first joined Farm Futures Magazine in 1987. In addition to analyzing and writing about the commodity markets, he is a former futures introducing broker and is a registered Commodity Trading Adviser. He conducts Farm Futures exclusive surveys on acreage, production and management issues and is one of the analysts regularly contracted by business wire services before major USDA crop reports. Besides the Morning Call on www.FarmFutures.com he writes weekly reviews for corn, soybeans, and wheat that include selling price targets, charts and seasonal trends. His other weekly reviews on basis, energy, fertilizer and financial markets and feature price forecasts for key crop inputs. A journalist with 38 years of experience, he received the Master Writers Award from the American Agricultural Editors Association.