Re-Entering Long Oil
- By Bilal Hafeez
- 2 min read
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At the start of March, we laid out a bullish case for oil prices and entered a long position. With the large volatility in oil around the ups-and-downs in the Russia-Ukraine conflict we ended up exiting the trade (at a profit). But we now think it is time to re-enter the trade for three reasons:
- Froth has gone. Oil prices appear to have returned to the pre-Ukraine war uptrend (Chart 1). So, the overshoot and its reversal appear to be behind us.
- US supply still lacking. The most recent US inventory and rig count data suggests a continued tight oil supply. Indeed, the US rig count has only moderately increased over the past month, despite the US being most incentivised to bring oil prices down. I’d note that the latest rig count is much lower than would be expected at current oil prices (Chart 2).
- Not just a play on US yields. Looking at various market correlations to oil prices, we find oil is currently negatively correlated to US yields – that is, higher US yields coincide with lower oil prices (Table 1). But the correlation is unstable, a month ago, the correlation had the opposite sign (higher yields = higher oil). So, we think the oil trend may not just be a play on US yields. Elsewhere, we find almost flat correlations between US stocks and oil.
As for the trade, the Brent curve is still heavily backwardated, so we go long the Aug22 (COQ2) contract. Moreover, given that 3m realised volatility in brent is 55%, we put the trade on in one-third of a position. The resultant volatility is then closer to that of an equity index long.
