The number of U.S. drilling rigs, an indicator for oil industry activity, dropped for the 18th straight week, a shift that carries potential implications for increasingly volatile crude oil trading and energy stocks. In the week ended April 10, the number of active U.S. rotary rigs fell 42 to 760, according to industry tracker Baker Hughes—a sign that U.S. oil companies are paring back energy production after feeling the pain of a 50% drop in prices since last summer.
Typically, commodity markets go in cycles. High prices breed more production for a while, which in turn ultimately lowers prices. Then lower prices deter production, which tightens supply, boosts the price anew, and the cycle begins again. But there’s been a shift; the world now has to count the U.S. as a significant new swing producer.
In fact, the advent of the shale oil revolution in the U.S. has disrupted global energy markets and created a unique role for U.S. energy companies. That means crude oil markets can rise and fall with the latest U.S. rig tallies, in addition to the typically closely watched inventory data.
"U.S. production is not only about to stop growing in the short term, but will begin to decline within the next few months," predicted analysts from Morningstar, in a global oil research update. "We expect more rigs to be taken off line in the coming months before rigs trough at almost 50% below 2014 highs …”
“Given this ability to quickly ramp up or down production, the U.S. has effectively become the world's newest swing producer, replacing OPEC in the role the latter recently chose to vacate," Morningstar said.
"People are watching the rigs coming off line and are expecting it to hit actual inventory numbers," says Shawn Cruz, trader content specialist for the Active Trader group at TD Ameritrade.
The Energy Information Administration (EIA) releases a weekly petroleum status report each Wednesday with the latest inventory changes. The April 8 report revealed a build of 10.9 million barrels, notes Cruz. Looking ahead, Cruz outlines two scenarios that could potentially break crude from its current trading range.
The bullish scenario: An inventory drop means the rigs coming off line are starting to reduce the supply of oil on the market, which could be the catalyst to increase price.
The bearish scenario: A greater inventory build could use up already stretched storage capacity; this could be a catalyst to push oil prices lower.
Interest in Options Gains
The increased scrutiny of oil numbers is showing up in options activity.
"On Friday, we saw both calls and puts trade five times the normal volume," says JJ Kinahan, chief strategist at TD Ameritrade.
But even with the volume pick-up, volatility remains subdued so far. The implied volatility (IV) percentile in crude options stands at 5% early this week versus the historical volatility (HV) percentile at 85%. "This means we could look for crude oil volatility to stay in a tight range or for crude oil to have a breakout and then implied volatility should return to the mean," Kinahan says.
Investors can monitor crude oil options statistics on TD Ameritrade’s thinkorswim® platform (figure 1). "Look at the Sizzle Index—a 1.0 is a normal day. On Friday, we hit 5.0," Kinahan says.
No Longer Range Bound?
Kinahan is tracking crude futures support at the $52 a barrel level, with $55 marked as resistance. “If crude oil breaks $52 it could easily fall further, while a rally through $55 could be the breakout," he said.
Big picture, the price of crude oil will continue to have far reaching implications for traders and investors. On one hand, consumers are typically heartened by cheaper oil and gas. But higher energy raises business input costs. "It will affect airlines, trucking companies and the stock market’s transportation index,” Kinahan adds. “With earnings reporting season starting, it will be interesting to hear what CEOs predict about oil prices going forward and how it will affect their business.”