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Waltzing through bullish oil prices but not so soon Fundamental AnalysisUnless there would be greater oil glut in the future than Iran’s contribution to the world oil supply (after sanctions lifted), I believe oil prices had hit its bottom in $27 range earlier in January this year. My general position is that oil price will go up but not so soon. To predict when and how the oil prices will go up, we must first understand why it dropped drastically from $110-120 range since June 2014 to the current $28-$40 range. Oil prices had hit bottom to $27.88 in 1.5-year since June 2014. Although this is not as fast as the sudden drop occurred in 2009, the leading cause remains unknown. It is widely stated that an oil glut is one of the reason for oil burst. Oil glut occurred because too many oil supply in the market against the demand. Recently, the international sanctions against Iran was lifted in January which enables Iran to return to the international oil market. This explains the $27.88 record low in January 2016. If we traced back earlier in June 2014, we see the rising problem of oil glut globally. The cause could be weak oil demand and oversupply. China and India, in fact most countries in the world experience economic slowdown. Oil prices tend to response to geopolitical and economic turmoil. If major producers continue to pump at high levels without corresponding demand, the oil glut would remain. Oil glut would cause the oil prices to remain low. Many smaller companies, especially those with high production costs, would not be able to make a profit and will eventually be forced to close down until a point where the oil supply corresponds closely with the oil demand. On the supply side, policies from the OPEC and other leading oil producers such as Russia, USA and Canada would have significant impact to the oil prices. However, given the current economic condition, it is unlikely for these countries to cut the oil production significantly. On one hand, OPEC and other big players would be benefited by low oil prices to drive out higher-cost producers out of the market. On the other hand, low oil prices would cut their profit and possibly create cash flow problem in the short term, but they would eventually need to make a profit. When OPEC cut down their oil production, it sends out signals as to how much loss they can take and for how long. Eventually smaller players of high cost oil producers will be out of the market, and only big players remain. In such situation, there are at least two observations in the present time. First, some countries rely more heavily on its oil production (including Iran) would not cut down their oil production easily compared to countries with moderate reliance (including Russia, Saudi Arabia, and others) or less reliance (including USA, Canada, and others). Secondly, countries with low oil production costs would be able to withstand the low oil prices compared to those with high oil production costs. Time is an important variable here and things continue to change gradually. For example, weak Russian Ruble and cheap labour in Russia would translate to low oil production costs. Since their cost of production is low, they would not cut down their supply easily compared to those with higher cost of production. This explains the previous disagreement between Russian and OPEC, or Iran and OPEC in term of cutting their oil production. However, it is always possible to have agreement in the future depending on the negotiations or win-win solution. As a result, we would see oil prices rally between certain level. There are at least three possibilities as to the current range of oil prices: oil prices would move between $30-$40 (most likely range or 60%) or $40-50 range (more likely or 30%), or $20-$30 range (less likely or 10%).On the demand side, the biggest consumers for oil such as USA, China, Japan, India and Russia would have a huge impact to push the oil prices up. A close watch to their economic outlook will give stronger signals as to the bullish waves compared to bearish waves. Economic outlook of big economies such as UK, Germany, Brazil, and others would have some impact to the oil prices. Technical Analysis After 2000 Dotcom bubble, it took about 4 years for oil prices to reach $40 level (“2000 Dotcom Bubble”). Even after the financial crisis in 2008, the oil prices went up again from $40 level to above $100 in about 2 years (“2008 Financial Bubble”). The issue is how soon and how much the oil prices will increase from its current level. Given the seriousness of current global economic slowdown and geopolitical issues, the recovery would most likely take 4 years or longer (similar to 2000 Dotcom Bubble) and less likely to be shorter (like in the 2008 Financial Bubble). We would aim to reach $50-$60 (more likely) or $40-$50 (most likely) range in one year. After period of shaky economic prosperity and financial bubble evidenced in the global financial crisis, it will take longer time for the market fundamental to stabilize. Financial ModellingWhat is the fair market price for oil? It is always more difficult to predict futures or commodities compared to stock prices. In the case of oil, we can look at the cost of production. Every big player has different cost of production depending on many factors and the figures are never fixed. The 2016 oil cost of production is estimated to be mostly between $20-$40. The following 2014 marginal production cost by country must be adjusted with currency value, labour cost, interest rate, regulatory regime, etc. Recommendation Unless we see positive economic outlook in the major oil consumer countries, the appropriate technique now would be to buy oil with lower $3-$5 margin and sell oil with higher $5-$10 margin. Depending on the situation, I would recommend to start buying within $30-$40 range and start selling within $41-$50 range. A good time to make a trade is between pre and post economic data releases or OPEC meetings or other significant events affecting the oil prices. ................
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