Daily volatility in crude oil, specifically, NYMEX Light Sweet Crude Oil Futures make headlines and along with those headlines seemingly endless speculation about what is happening, when it will stop, how to make money, etc.
Crude oil daily volatility as measured by the Chicago Board Options Exchange (CBOE) Crude Oil Volatility Index (OVX) peaked at 69.12 during the first Greece crisis in 2011.
The OVX peak in 2011 was a one-day event. This year the OVX has rarely been below 60 demonstrating the sustained volatility in the market.
In the midst of the chatter certain terms may be used without their meaning clearly understood. One term that is regularly discussed with a malleable definition is energy independence or specifically petroleum independence wherein the U.S. no longer imports petroleum, crude or otherwise. The discussion is impacted by repeal of the ban on crude oil exports this year and news of shipments leaving the gulf coast .
The reality is that the United States is far from petroleum independence and it is questionable if we ever will be or if that is even desirable.
The U.S. currently produces 8.7 Million (MM) barrels (Bbl) per day from the lower 48 United States according the Energy Information Administration (EIA). The following chart displays daily production for the past decade.
This production figure is important because it excludes Alaska and reveals the impact of multi-stage hydraulic fracturing applied to non-conventional formations, shale, and/or formations previously uneconomic to explore and produce due to extremely low permeability.
Alaska, once a key source of U.S. oil production has declined in significance. The following chart is U.S. field production including Alaska and details daily U.S. production of 9.21MM Bbl/Day.
The source of the dramatic rise in production is the aforementioned technology advances in completion combined with years of tremendous exploration and production activity.
Exploration and production (E&P) activity also known as ‘upstream’ is defined here by the Baker Hughes Rotary Rig Count for North America and the U.S. The Baker Hughes data may be broken down into just the U.S. and further by rigs drilling for oil versus natural gas or total drilling activity.
Rotary rigs exploring for oil in the U.S. are detailed in the chart below.
After peaking at more than 1,600 in the fall of 2014 the rig count exploring for oil has declined below 500, a level not seen since exiting the financial crisis more than five (5) years ago.
Total rig activity in North America is even more dramatic and displayed below.
The record for total rig activity is 1,988 in the fall of 2011. Total rig count declined while focus shifted from natural gas to oil then rose again to a peak of 1,859 in the fall of 2014. Since then it has declined dramatically to 543, the lowest activity this century.
The extraordinary rise in E&P activity combined with the aforementioned completion techniques in non-conventional formations resulted in the record production levels, but still has not yielded petroleum more energy independence.
US petroleum imports are detailed in the chart below. Weekly reports are highly volatile and the data has been smoothed with a 52-week exponential moving average (EMA) in the shaded blue region
Imports peaked at more than 11MM Bbls/day and then declined by a third to now approximately 7MM Bbls/day.
A useful analysis of how close the United States is to achieving energy or petroleum independence is to subtract imports from production in the chart below. Consistent with the volatility in the import data the chart below is smoothed using a similar 52-week EMA shaded in blue.
A red horizontal line is drawn across the data at zero. When the values are below zero the US is importing more oil that it’s producing when the values rise above zero the US is producing more oil than it is importing.
The US is producing more oil than importing since the fall of 2013, however it is important to emphasize again that the US still imports approximately 7MM/Bbls/day.
It is natural during this time to ask when will oil prices bottom and begin a new bull market. Historically such a dramatic decline in E&P activity results in decreased production and prices rise. This time production has been slow to correct while rigs of been stacked out by the hundreds.
The chart below compares US field production to the Baker Hughes U.S. rig count of rigs exploring for oil
Since its peak of 1,609 Riggs in the fall of 2014 to 498 rigs of this weeks report, 69% decline, US field production is increased from 8.95MM Bbls/day to 9.21MM Bbls/Day, a 2.9% increase.
Until production declines commensurate with the reduction in E&P activity and excess storage volumes are worked off it is hard to envision a new bull market in oil.
The latest boom in U.S. crude oil production pushes the U.S. nearer petroleum and energy independence. There is still much to do before the U.S. is a net exporter of petroleum and current economics challenge the notion that we will achieve complete energy independence in the near future.
ADP's Research Institute issues a monthly employment report the Wednesday prior to Bureau of Labor Statistics (BLS) Employment Situation. The data is correlated, but not generally predictive of BLS. ADP does a nice job of breaking down the employment situation by sector. BLS attempts this also, but because of their survey methods it is challenging to compare apples to apples across the A and B tables of data in the BLS report.
ADP breaks jobs into three (3) sectors in their historical data: Goods Producing, Manufacturing, and Service. I believe these data sets harbor the gloom mentioned with respect to employment. Manufacturing and goods producing jobs tend to be full time, more predictable schedules, and perceived offering better pay. Service sectors - especially blue collar - tend to be a mix of part and full time, irregular hours, and lower compensation and benefits than manufacturing or goods producing.
The first chart is ADP's Non Farm Private Payroll data.
The robust jobs situation is evident with 120.21 million jobs in October 2015 versus the previous peak of 115.98 million jobs in January 2008. This is the positive portion of the data.
Digging into the three sectors the data is less compelling.
ADP Non Farm Private Goods Producing Jobs are detailed in the next chart.
Unlike total non-farm private jobs, Goods Producing is lagging its previous May 2006 peak by ~3 million jobs.
Manufacturing jobs are equally weak in the next chart.
Not shown in the Manufacturing chart for brevity and to isolate on the past decade is that this data's peak is January 2001 at 17.16 million and has declined steadily with only a recent recovery from 2008's financial crisis to 12.26 million; 4.9 million jobs less than the January 2001 peak.
Goods Producing and Manufacturing jobs are combined in the following chart to show the decline of these sectors.
Not surprisingly the picture is still woeful for these combined sectors.
So where is the positive delta for total jobs coming from? Service. Service sector jobs are detailed below.
The previous service sector peak was ~94 million jobs in January 2008 and today prints 100.8 million jobs, a 6.8 million job increase and almost entirely responsible for job growth out of the great recession last decade.
Going back to October 2007 service jobs were less than 75% in the pie chart below.
The latest report for October 2015 below demonstrates how our economy is evolving more into a service economy challenged with the limitations generally associated with service sector jobs, particularly blue collar service sector jobs.
Is this the source of the gloom many folks express when discussing the jobs situation?
July is an important month for Americans in oil and gas exploration and production. Each year we celebrate the birth of our nation, 239 this year. July 2015 we also celebrate one (1) year from when NYMEX WTI traded above $100.
July 3, 2014 NYMEX WTI Light Sweet Crude Oil Futures (CL) settled at $104.06. That same day the Dollar as measured by the U.S. Dollar Index® Futures (DX) on Intercontinental Exchange (ICE) settled at $80.281.
Energy professionals are intimately familiar with crude oil’s decline in the year since we last celebrated our nation’s birth. Mainstream media has attributed falling energy prices to the high rig count, record production, record storage, refinery strikes/outages, and occasionally weak demand, all of which affect hydrocarbon prices. On rare occasions the dollar is included in the discussion.
Crude oil an internationally fungible commodity denominated in U.S. Dollars and thus there is a defined mathematical relationship between the U.S. Dollar (DX) and NYMEX WTI (CL), specifically an inverse relationship.
Correlation is a statistical term that helps show if and how strongly two (2) instruments are related. Investopedia defines it as a statistical measure of how two securities (instruments) move in relation to each other. Specifically correlation quantifies how the change in two instruments is related to each other.
Correlation is positive when two (2) instruments increase by similar amounts in relation to each other.
Correlation is measured in a range from -100 to 100 or -1 to 1 depending on the calculation and convention and is frequently referred to as “R Value” or just “R”. Any correlation greater than 0 is positive correlation and the higher and closer to 1 or 100 the more significant the relationship. Correlation of 1 or 100 is perfect positive correlation with anything more than .5 or 50 considered strong.
If two instruments move opposite each other by same or similar amounts they are negatively correlated. Negatively correlated instruments have an R-value less than 0 with -1 or -100 being perfect inverse correlation. An R less than -0.5 or -50 is a strong inverse correlation
Crude Oil and Dollars
The background mentioned the settlement prices for Dollars (DX) and crude oil (CL) when we last celebrated Independence Day, how does that compare to this year?
July 3, 2014
July 3, 2015
The decrease in NYMEX WTI has been more significant than the increase in the Dollar, but their inverse/negative correlation is obvious and quantifiable. The following analysis uses Updata Analytics and data from CME Group and ICE via ESignal/Interactive Data.
The change in both instruments is most evident when their prices are visually compared in the following chart with NYMEX WTI in the top pane and the Dollar Index in the lower.
The historical negative correlation is only marginally evident in 2012 and 2013, but from the middle of 2014 to date the charts are almost mirror images.
The historical inverse relationship between the dollar and crude oil is displayed in the next chart. Crude oil is on the vertical axis and Dollar Index on the horizontal.
The inverse relationship is obvious in the red downward sloping line that intersects the scatter diagram of NYMEX WTI versus Dollar Index prices.
The historical R-value of the relationship is (79.35), not a perfect inverse relationship, but it does demonstrate strong negative correlation of the two instruments.
Comparing NYMEX WTI to the Dollar Index the inverse relationship is most evident in the second half of 2014 extending into 2015. The increased correlation during the past year is quantified in the next chart.
The 12-month chart is much more neat and symmetrical than the long-term chart owing to the more significant negative correlation between NYMEX WTI and the Dollar Index (DX). The R-value for the past year is (90.66) a near perfect inverse relationship.
The more negative correlation between the dollar and oil during the most recent bear market in oil cannot be overstated. While the two have a measurable historical inverse correlation the past year has nearly perfected the relationship.
The next logical question is which instrument follows and which leads? Did oil’s decline lead to the dollar’s rally or vice versa. It isn’t easy to know the answer; they are both driven by global macroeconomics. The Federal Open Market Committee (FOMC) heavily influences the dollar and the past year speculation about if/when the FOMC will start raising short-term interest rates has been the driving macroeconomic factor.
Conventional wisdom (two most dangerous words in trading) is that the FOMC will raise short-term rates later this year and gradually thereafter lending support to the dollar. If that is the case expect more downward pressure on crude oil. If the FOMC delays raising rates and the dollar falls crude oil can be expected to climb.
Until the FOMC question is resolved expect more volatility. To quote Mike Brown at Palmares Energy: “We are all FOREX traders now”.
The rapid decline in crude oil prices and subsequent volatile rebound has been attributed to many things, most all of which are contributing factors, by the mainstream media. One key factor has been mostly left out of the discussion – crude oil’s inverse relationship to the dollar.
There have been many days with no announcements or economic reports where oil moves dramatically, like today. July 3, 2015 NYMEX WTI settled down $1.41 or (2.48%) and there were no OPEC meetings, storage reports, rig count releases, peace treaties signed, or other economic news flow. The Dollar Index settled up 0.11 or .11% and sometimes that is all it takes to help generate weakness in crude oil.