Learning From the Past

This week in the crude oil spot price Monday opens with an initial loss of around 1.2%. A dead market with less than one hundred thousand trades on the New York Mercantile Exchange is lulled once more into sleep where nightmares are dreamed up and market sentiment reacts further to nightmare fundamentals. One has to wonder when the market has determined an equilibrium price because supply and demand energy data is remaining stable with tiny increases in rig count and similar sized decreases in overall stocks. Reacting to downward movement, the oil and gas industry shows more weakness as XOI (Oil Industry Index) loses 6.65 points or 0.54%, the biggest loser currently Chevron down 1.08%. Although, some companies show small gains including Marathon. Phillips 66, Valero, and Exxon-Mobil mostly likely because of the small gains in gasoline prices from the shutdown of BP's facility. Natural gas contract prices and its respective index show similar losses to a smaller degree (XNG losing 0.05% currently). Curiously enough, crude oil ETFs show some resistance to the losses sustained by the crude oil spot price with OIL and UCO fighting to stay even and the high volume, accelerated return security UWTI tries to retain a penny gain (increase of 0.95%) to its incredibly cheap price. The international benchmark also shows hints of a loss but is also bouncing off its a resistance set at the opening of the day.

These declines come after extensive losses that have been continuing for a year now. The slump now entering its 13th month revealed a supply glut that sent prices tanking to levels that are $60 below what they were. Investors might look back to the crisis in 2009 and see a similar story. A $100+ price drop sent shocks throughout the oil industry as the global economy fell on its backend. Starting in June and lasting into the next year, the 2008-2009 crisis in not just a curious phenomenon of global economics but something that we should be studying. May this be a brief introduction to a topic I'll revisit many times. May you enjoy it as I do.

The charts above plot the spot price of WTI over two periods, the top 2008 crisis (June 2009 - June 2009) and the bottom 2014 slump (July 2014 - July 2015). The span of both periods is 12 month, one of many similarities that characterizes both price slumps. In twelve months, the WTI spot price in both periods initially plunged for the first seven and a half months including a month and half rebound with the establishment of a new low.Therefore, we see huge similarities in the shape of the graph showing the drop in prices although in 2008 the range of the data is larger. This could probably be explained by the total economic failure in 2008 that created a larger shock than the current one. in 2014. The crash of the stock market not only sent securities to new lows, but confidence and security in those securities disappeared creating an enormous flow of capital out of the finance mechanism. This price crash was not an issue of supply and demand, but a total failure of capitalism and investors investing in that way. But also, the issue was supply and demand. As balance sheets were dismantled and painted red, the oil industry saw global demand and economic growth dissipate in a matter of weeks. Specifically, we may speak of the industrial sector where durable goods and construction saw major losses in revenue and jobs after the real estate bubble popped. On the other hand, the 2014 crash came after growth in the oil industry where frackers used technology to explode supply growth beyond recovering demand and consumption statistics. As a fundamentally based shock, the 2014 supply glut consisted of daily speculation-based losses as data and news gradually revealed markets out of equilibrium causing deflationary pressure. So that's the background, two shocks, one quick plunge a result of systemic failure and another gradual decline with unpleasant fundaments. So then why are the time frames so similar? Well, one must remember that the 2008 crisis saw a larger drop than 2014 as well as a problem with a global scope as opposed to national, but that doesn;t discount technical similarities. Both price trends rode the bottom Bollinger Band for six months until momentum supported a small recovery that ended in a new low after a month and a half. Perhaps there is a distinct structure that price trends follow during shocks. Differences emerge after the initial shock (inside the blue box) and are represented by the blue arrows on the charts. One key event can help explain why the 2015 rebound was not sustained as it was in 2009. In the beginning of the year after the global financial crisis, OPEC produced a new output quota that reduced production by 3 million barrels a day or 5% of global production Immediately following the new quota, a recovery turned into a breakout of almost $20 as summer demand helped prop the price up to the $70 level. If this were to be a perfect replay of the 2008 crisis, OPEC would have reduced production in April assisting speculative efforts to regain ground on the slumped price. That did not happen so we see the double bounce behavior in early 2015 turn into a parabolic shape that reverses increases in March and April. That gives enormous credibility to OPEC and their speculating rousing authority but is it evidence enough to trust the oil market's revival in their hands? In reality, the slump in late June and July could be due to the demise of OPEC. As the oil cartel's influence is clearing challenged by new reserves in the United States so is the hope that quotas can solve the price problem. It just may be the reality that real market determined prices are as low as we imagined. This is one of many lessons found in the studying of the 2008 and 2014 price plunges, and one that investors should remember when holding on to a long position with faith in our favorite oil cartel.


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