Crude oil prices finally turn a corner in February
After declining for 7 straight months, crude oil prices finally turned a corner in February, posting a 3.5% gain for the month. This has many investors wondering if we're done with the declines and perhaps ready to start a new uptrend in the energy patch. After hitting a low of $44 per barrel in mid-January, prices quickly rebounded to almost $55 before faltering back to the $50/barrel level by the end of the month.
Brent crude oil had a even more impressive month, gaining almost 19% in February. While West Texas has been bogged down by oversupply in the North American energy markets, Brent has been benefiting from continued unrest in Libya. After coming almost to par in mid-Janaury, the spread between Brent and West Texas has begun to widen again, reaching over $12 per barrel by the end of February.
US energy stocks have shown incredible resilience and also posted a good February, gaining 3.5% for the month. The US energy index is comprised of very large, diversified and integrated energy majors and independent refiners, which benefit from the crack spread - or the difference between the price of crude oil and gasoline. This has helped limit the slide in the US energy sector.
Canadian energy stocks have been hit harder by the decline in crude prices, due in part to the fact that 50% of Canadian oil production is sold as non-upgraded bitumen, which sells at a considerable discount to West Texas Intermediate. The Canadian energy sector also contains more oil sands players, which have a higher cost of production than conventional oil producers.
So are there any clues on where prices might be headed? A look back at the 2008 crude oil collapse might provide some insight. After beginning its descent from $144 per barrel, crude oil prices first hit a low of $35 in late December 2008. Prices then rebounded, reaching almost $50 by early January, then began to slide again, going back to $35 by mid-January. After a short rebound, prices slid lower again to $33.50 by mid-February. That third re-test of the lows in the mid-30s was sufficient to form a base and prices then slowly began to climb.
The retesting of lows is an important indicator for traders searching for a bottom. In most cases, when the price of a stock or commodity rebounds off a low, prices often fall again and retest that previous low. A very good sign would be a price pattern which fails to break an old low (or forms a higher low). Most energy traders agree that crude oil prices need to hold above the $44 low of mid-January before any talk of price recovery can commence.
What's another important indicator? The US dollar, which underpins the price of all commodities. It's no coincidence that the most recent 7 month decline in crude oil coincides with a 7 month rise in the US dollar:
The US dollar began its historic downward slide from 2002 to 2008, which coincided with one of the longest commodity runs in history. When the financial markets began to free-fall in 2008, investors fled to the safe-haven of the greenback, which caused the US dollar to rise sharply, pulling all commodity prices down. The US Federal Reserve responded by lowering interest rates, which caused the US dollar to pullback and kept the dollar at historic lows for several years. The low dollar proved bullish for crude oil price, and in fact all commodities, which recovered relatively quickly.
So is it different this time? Yes, very much so. US interest rates are presently at near-zero levels, and are likely to begin rising before the end of the year. Rising interest rates are bullish for the US dollar, which would be a serious drag on commodity prices.
Of course, that doesn't mean oil prices can't rebound. It does, however, greatly reduce the probability of a quick bounce back to $75 any time soon.