By Colin Cieszynski, CFA, CMT, CFTe, Chief Market Strategist Crude oil entered 2015 coming off a once in a generation price collapse driven by a market share war among suppliers amid sluggish demand. In recent months, WTI and Brent have paused to assess the damage and consolidate their losses but there remains a risk that their broader downtrend could resume in the coming weeks and months. How low could crude oil go? Currently WTI crude is trading near $45.00. Some OPEC members have suggested they could be comfortable with $40.00 oil and the 2008 low was near $35.00 suggesting a $35-40 range where oil could potentially bottom out. There have been calls from some quarters suggesting that even lower prices may be needed to force producers to actually cut production and not just slow exploration. The big question facing traders this quarter is what is the actual breakeven price for producers? As the price has dropped, producers have cut back their exploration and capital budgets, and are likely to force price cuts on their equipment and service providers. This means that cost structures may come down in the coming months as well, so it may take significantly lower prices to put enough pain on producers to force then to align production with demand. US inventories and storage capacity may also be a topic of conversation in the quarter. All else being equal, as refinery strikes end and retooling for summer gasoline production is done, inventories should start to fall in the quarter. If they don’t, however, it would be a bad sign indicating the supply overhang is an even bigger problem than already thought. How long could oil prices stay down? Although central banks have been talking about the impact of lower oil prices in inflation as short-term, history suggests that having collapsed, oil prices could stay down for a long time. In the table below, we have looked at how long oil prices have stayed down after major declines.

WTI Crude Oil   
$25Jan '86Aug '9056
$25Jan '91Dec '9672
$20Nov '97Jul '9921
$30Dec '00Sept '0222
$100Oct '08Mar '1130
$80Oct '08Mar '1018
$100May '12Jul '1315
$100Jul '14 9 so far
$80Nov '14 4 so far

Source: CMC Markets The record shows that once oil has gone down for the count, it has tended to stay down for several years. Looking at the last time $100 and $80 were broken in quick succession like this year, it took oil over a year to regain $80 and a year and a half to regain $100. Seasonality in oil trading Historically oil has been seasonally strongest between February and April, then July through September with October and November historically weak. As I did earlier with stock markets I also looked to see if there were any seasonal patterns in how crude oil traded through 1986 and 1999 two post-oil crash years that potentially appear to be most similar to 2015. Those two years didn’t really help identify any seasonal patterns as they often mirrored each other but they did indicate that April could be a particularly positive month for WTI. One thing looking at those two previous years’ action does indicate is that we may see much higher than average month to month moves in the oil market and that big moves in both directions appear possible. This suggests market conditions may favour short term trading over long-term positions and that several opportunities may appear for both bulls and bears over the course of the year, so it’s important not to get to attached to any one side. WTI Crude Oil Monthly Change

Month19861999201525-year average
March(21.42%)36.59% 4.72%
April28.02%11.34% 2.26%
May7.20%(9.75%) 0.43%
June(10.63%)14.55% 0.93%
July(12.75%)6.43% 2.20%
August42.60%7.70% 1.55%
September(7.11%)10.85% 2.68%
October3.39%(11.26%) (2.57%)
November(1.77%)13.06% (2.39%)
December19.60%4.11% 0.30%

Source: CMC Markets Drilling, production and the oil price During the first quarter, a number of traders started to latch on to the Baker Hughes US drill rig count, thinking that lower drilling activity could lead to lower US production. Because of this, action in oil markets picked up a few Fridays around the time of the report. As the quarter progressed, traders started to go back to ignoring the report as they had for the last several decades. It turned out that when cutting back on drilling, producers focused on their top prospects and put their more marginal plays on hold so the impact on production may not be as big as thought. The chart below shows that the relationship between US drilling and production is negligible. Check out the period between about 2002 and about 2008 when drill rigs increased and production decreased as more marginal prospects were explored. Similarly, through the 2000’s US production kept falling while the oil price was rising. There may be some influence but oil traders may not want to hang their hat on the relationship between price, drilling activity and production levels. In Q2, this indicator may continue to fade back into obscurity for crude oil trading. Drilling rig counts may continue to be used by stock traders when evaluating the earnings prospects of oil and gas service companies. Note the Canadian drilling activity varies dramatically between seasons with winter the most active as many pad locations are in remote areas that can only be accessed over frozen ground and lakes. Spring breakup brings a period when heavy equipment is banned from roads, so exploration usually pretty much grinds to a halt for a few weeks so don’t be surprised if the drop is even more dramatic this year. US drilling activity, oil production and WTI 1990 to Present Source: CMC Markets Political instability and oil trading It seems almost unbelievable considering how much oversupply, a market share war among suppliers and high storage levels in the US have driven crude oil prices down over the last six months, that political instability would start to impact oil trading again. In late March, Saudi Arabia started to get involved in Yemen’s civil war launching air strikes, and growing turmoil threatened to drag in other countries like possibly Iran or Egypt. This caused crude oil prices to jump 5% one day although the rally quickly faded. The importance of Yemen for oil markets is not its production, rather it is because the country sits on one side of the Bab-el-Mandeb strait which joins the Persian Gulf/Indian Ocean to the Red Sea and Suez Canal. The makes it one of the world’s key transit points for energy. Recall a few years back when Somali pirates regularly attacked tankers in the approaches heading toward this strait. The impact of political instability in oil markets comes and goes, and world events may continue to influence oil trading. The biggest impact may be on the spread between Brent Crude and WTI Crude which has been narrowing in times of oversupply in the markets but could widen if a political risk premium starts to be applied once again. Growing instability may also keep the pressure on the US to grow its domestic production and maintain the trend toward energy independence, which could also depress WTI relative to Brent. Focus Chart: WTI vs Brent, natgas and gasoline The chart below shows that through much of the oil price crash, WTI, Brent and gasoline all followed similar paths downward. In the stabilization phase of February and March, their paths diverged. Gasoline bounced back due to refinery strikes in the US and Brent appears to be building a political risk premium once again. There’s no guarantee that the selloff is over and if a new downleg starts, gasoline and Brent could catch up to WTI on the downside. Natural gas did not fall off the cliff as fast in the autumn of 2014 because it benefitted from a favourable seasonal period for its trading at the start of home heating season. This year’s seasonal bounce was smaller and ended much quicker than usual. Since the end of November, natural gas has been following the energy group lower and the gap has been closing, particularly with gasoline which is entering its own favourable seasonal period as winter ends and summer driving season approaches. Source: CMC Markets For more information on how the oil price crash may impact oil-sensitive currencies and energy stocks, please see our related article "Canada and Norway try to pick up the pieces after oil crash" By Colin Cieszynski. CMC Markets is an execution only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.