Bearish Oil Price Forecast: The Sun is Setting

This article was written by Cole Winston, a Financial Analyst at I Know First.

Oil Price Forecast


  • Oil Fundamentals: Cyclical Movements or Secular Shifts
  • United States Oil Fund (NYSE: USO)
  • Price Action
  • Bearish Forecast

For something that is so central to the functioning of modern-day society, there is an ever-growing degree of uncertainty surrounding the near-term and long-term fate of the one commodity that is the axis of modern society: crude oil. As the fuel that powers the majority of the world, and as a feedstock or raw material in a variety of other oil-based petroleum products, crude oil prices are largely at the whims of geopolitical, geo-strategic and geo-economic forces – in addition to standard supply and demand – due to its strategic importance. For the past several years (from 2014 onwards), the dominating narrative on the outlook of oil has been whether oil is simply experiencing cyclical fluctuations or rather if it is, in fact, in secular decline. Nevertheless, the I Know First machine learning algorithm has predicted a bearish forecast for the black gold – as it is known – over the 1-month, 3-month, and 1-year time horizons.

Oil Fundamentals: Cyclical Movements or Secular Shifts

Historically speaking, there is an abundance of uses – and therefore demand – for crude oil. In no particular order, these include natural gases, fuels (gasoline/petrol, diesel, jet fuel and kerosene), naphtha, heating oil, paraffins and waxes, and the list goes on. It should now be clear just how pivotal a role crude oil plays in the functioning of modern society.

Basic supply and demand dictates that lower prices are a direct consequence of a supply glut or surplus. A surplus can be caused by rising supply, falling demand, or both; the latter of which causes the strongest price movements. What happened as it relates to oil was this third option. There are three factors that contributed to this dynamic.

First was the massive general oversupply that resulted from the U.S. shale energy revolution. The extreme price hikes that occurred during the early 2000’s commodities supercycle – of which crude oil participated –  brought with is a desire of upstream oil producers to pump out as much oil as was physically and technologically possible. This sparked intense competition that ultimately led to technological innovation in the form of shale oil hydraulic fracturing (“fracking”) technology. The spread of this technology throughout this period led to a production ramp-up that was so extensive in nature that it is still going on.

Second was the use of oil as a geo-strategic tool in navigating geopolitical rivalries. Although others exist, the major geopolitical dynamic was (and still is) the Gulf Cooperation Council (GCC) bloc versus Iran. The GCC, comprising the energy-rich Gulf monarchies of the Middle East (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates), is largely a bloc of Sunni Muslim nations. Iran, on the other hand, is the sole leader of Shia Islam globally and represents the greatest strategic threat to the Sunni bloc (de facto led by Saudi Arabia). Because oil is the largest commodity export in the Middle East, it is also the most potent geopolitical weapon of choice in the ongoing battle for Middle-Eastern supremacy between Saudi Arabia and Iran. The result was a battle for market share between both parties. So when Iran was sanctioned out of the market, Saudi Arabia capitalized on the opportunity by producing as much as possible to pick up former Iranian market share and to severely damage the Iranian economy with plummeting oil prices; something the Saudis believed they could weather more so than their Iranian counterparts. The result compounded the fall in oil prices brought on by the shale revolution.

Third was the remarkable fall in global demand due to the economic deceleration of emerging markets. Slowing growth in emerging markets, most importantly in China, only added fuel to the fire of falling oil prices. As the largest importer of crude oil exports, the sudden slowdown in economic growth and production in China compounded the extreme bearishness in oil prices and has only continued in light of recent official policy shifts towards a consumption economy and away from a production economy.

The ultimate consequence of these three factors was that crude oil prices, reflected in West Texas Intermediate (WTI) light sweet crude spot prices, plummeted from a high of $115 per barrel to a low of just below $27 per barrel; an almost 325% drop.

Facing unimaginable hardship, oil producers and spectators generally believe that oil will return to its former glory days. However, the secular outlook for crude oil is bearish due to the irreversible, structural headwinds facing those with vested interests in the oil patch. The main factor at work is concerns of climate change or global warming. Amid growing concerns being voiced of the damages to the environment that have been caused by the production and consumption of fossil fuels, both energy producers and governments have embarked or are embarking on a new path towards alternative, renewable energy and the ultimate abandonment of fossil fuels. Although some conventional oil and gas producers have been approving new projects at a fast rate, companies are now re-focusing strategically to capitalize on growing renewables investment and technological advancement, in addition to automobile companies aiming to reduce or completely end production of internal combustion engines, as well as countries aiming to reduce or outright ban these products.

The above analysis can also be seen in the price action of crude oil, represented here by the United States Oil Fund (NYSE: USO).

United States Oil Fund (NYSE: USO)

The I Know First algorithm is currently bearish on the United States Oil Fund.

The United States Oil Fund (USO) is an exchange-traded fund (ETF) designed to track the daily price movements of West Texas Intermediate (“WTI”) light, sweet crude oil (the underlying commodity of New York Mercantile Exchange’s oil futures contracts). The investment objective of USO is for the daily changes in percentage terms of its shares’ NAV to reflect the daily changes in percentage terms of the spot price of light, sweet crude oil delivered to Cushing, Oklahoma, as measured by the daily changes in price of USO’s Benchmark Oil Futures Contract, less USO’s expenses. USO’s Benchmark is the near month crude oil futures contract traded on the NYMEX. If the near month futures contract is within two weeks of expiration, the Benchmark will be the next month contract to expire. The crude oil contract is WTI light, sweet crude oil delivered to Cushing, Oklahoma. USO boasts a competitive management fee 0.45%, for a total expense ratio of 0.72%.

Price Action

The price charts below* help visualize the above historical and current developments in the oil markets. As can be seen on both the monthly and weekly timeframes, from 2014 onwards the price of crude oil proceeded to plummet to the lows where it has been stuck and declining ever since. On the daily timeframe, however, some recent bullish price action can also be seen. However, the cause of this sentiment is simply the result of recent short-covering in reaction to announcements of U.S. sanctions against Venezuela and OPEC finally beginning to limit oil inventory stock, both of which are bullish for near-term oil in light of ending the global oil glut.

*Chart Guide: white candles represent the close being higher than the open (an up candle), black candles represent the open being higher than the close (a down candle), the top chart represents monthly candles, the middle chart represents weekly candles, the bottom chart represents daily candles, the red line is a moving average, and the price data is sourced from BATS (an electronic exchange platform).

Bearish Forecast

Nevertheless, the outlook for crude oil still remains bearish, as is reflected by the I Know First algorithm.

The I Know First algorithm is bearish on USO over a 1-month, 3-month, and 1-year time horizon. The I Know First algorithm was previously bullish on a 14-day timeframe as of September 22nd, 2016. The algorithm was proven correct in its forecast when USO generated a return of +10.67% to the upside. This bullish short term forecast for USO was sent to the current I Know First subscribers on September 22nd, 2016.

I Know First Algorithm Heatmap Explanation

The sign of the signal tells in which direction the asset price is expected to go (positive = to go up = Long, negative = to drop = Short position), the signal strength is related to the magnitude of the expected return and is used for ranking purposes of the investment opportunities.

Predictability is the actual fitness function being optimized every day, and can be simplified explained as the correlation based quality measure of the signal. This is a unique indicator of the I Know First algorithm, allowing the user to separate and focus on the most predictable assets according to the algorithm. Ranging between -1 and 1, one should focus on predictability levels significantly above in order to fill confident about/trust the signal.



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