Canada Markets

Following a gap lower to begin trading for the Oct. 28 session, the crude oil market has failed to bounce back enough to fill it -- as of the morning of Oct. 30 anyway.

Monday's losses of nearly $5 per barrel at one point were the result of a market interpretation that risk from Middle East tensions declined with the targeted retaliatory attack by Israel against Iran. All energy infrastructure was spared; the market assumed it marked an end of this tit-for-tat round.

Grain and oilseed markets came under pressure because of their energy components, particularly the vegetable oils. Prices have rebounded somewhat, but gaps lower have yet to be filled in soybean oil along with crude. In general, gaps mean little as long as they can be filled within a few days; but if not, they take on a more serious role -- a breakaway gap lower in this case.

It is worth noting that the longer time goes by without a serious downdraft, the less likely it is a breakaway gap, the more likely it is traders will have the confidence to buy, and the more likely it is to be filled. That said, given the implications, further analysis is justified.

A brief history lesson on crude oil pricing would be a worthwhile exercise at this point. The Russian invasion of Ukraine in February of 2022 resulted in a spiked high of $130.59 per barrel. Following a brief pullback, prices rose back up to $123.68 per barrel by June of 2022 as democratic nations tried to punish Russia by attempting to restrict their energy exports.

The Biden administration then tried to encourage various countries to increase production to offset lost Russian exports; there was little to show for their efforts.

The United States then turned to the U.S. Strategic Petroleum Reserve (SPR) to help reduce the pain at the pump while doing what it could to increase domestic U.S. production. This is very important now, because the SPR was established in 1977 to provide a supply cushion of crude oil in case of emergency. At its highest, there were 726 million barrels in December 2009; at its lowest it was 347 million barrels, set in June 2023, just under half of the peak inventory. And, with 375 million barrels as of July 2024, the U.S. was at risk of a price spike in the event of a real emergency -- like an all-out war in the Middle East, for example!

It also helps one understand why the White House was reportedly trying hard to convince Israel to avoid an escalation or attack any energy infrastructure.

The SPR history lesson also helps us understand the recent price range in crude oil and the limited long-term impact on related markets. Facing mounting pressure that the drawdown was leaving the U.S. vulnerable, the Biden administration pledged to make purchases to replenish SPR supplies when prices neared $70 per barrel. This suggested a floor for price and helps to explain why most of the last 18 months we've seen prices trade within the $70-$85 per barrel range.

Getting back to our current situation, the $50 per barrel crude oil talk comes from possible tensions between Saudi Arabia and other OPEC+ members. In response to post-invasion declining prices, OPEC+ countries cut production quotas. Reports suggest Saudi Arabia is angry about members cheating and has threatened to flood the market as a form of punishment. They denied rumors that they would target $50 per barrel, but where there's smoke, there's often fire. Something to keep an eye on.

The potential for $100+ per barrel crude oil would obviously come from an escalation in Middle East tensions combined with the low SPR in the U.S. Initial reports from Iran suggested the country considered the matter resolved and would not respond to Israel's attack. By late Monday, word was coming out of Iran that some were pushing for a retaliatory attack that would surely escalate tensions further.

Another risk comes from the U.S. election in the coming days. A potential Trump administration would be significantly more confrontational regarding Iran, if history repeats. Instead of promoting restraint as the Biden administration has been doing, a new administration may instead encourage escalation. Such a development should be months away, following inauguration in late January, but worth keeping in mind given the ramifications.

Looking at the technicals for crude oil, the monthly chart's 100-month moving average comes in right at long-term support just under $65 per barrel. A rally off looks logical if tested, but if it fails, technical selling could be triggered. The weekly chart looks heavier with lower lows and lower highs during the past year. A break of support appears to be a valid risk in this case. The daily chart gap lower ($69-69.96 per barrel for December futures) needs to be filled soon or risks becoming a breakaway gap that could trigger such a violation of the $65 support.

The market participants themselves (as seen through the Commitments of Traders report) present an interesting picture. Money managers have a decade-long history of holding between 75,000 contracts net long and 425,000. They were net long 113,773 contracts as of Oct. 22. That suggests there is some room for further long liquidation pressure from this group should support fail. The big picture, however, is they appear far more likely to be looking for reasons to buy at this point. They have had quite a history of entering the long side from this small of a position. An escalation of Middle East tensions would be compatible with such a development.

Bringing it all together, barring any surprises, there appears to be a risk of a short-term break in crude oil that would likely weigh on grain and oilseed prices somewhat. Given the world is not likely going to embrace peace anytime soon -- and the tight SPR supplies or the desire to replenish those are not about to change -- long-term pressure seems unlikely.

Regarding fuel purchases, the simple risk management strategy I've been suggesting for the past 18 months seems the most relevant today -- when crude oil is trading around $70 per barrel, make sure the tanks in the yard are full. Other than that, just monitoring developments seems appropriate.

With that, keep in mind I'm always happy to get feedback along with any suggestions for future blogs.

Mitch Miller can be reached at mitchmiller.dtn@gmail.com

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