New Reality for Oil: A narrower trading range

After a long period of boom or bust, the new reality for oil prices is a narrower trading range that is frustrating many longer-term investors but has eased some pressure on big oil companies reports the Wall Street Journal.

U.S. oil prices are entering their sixth month of trading roughly between $40 and $50 a barrel. Many investors are betting the market may be choppy but will remain in that range through year’s end.

The relative calm reflects how U.S. producers, whose booming output from shale-oil fields pushed the global market into oversupply in 2014, have changed the industry’s dynamics. Their ability to quickly start or stop production has the market stabilised at lower prices.

Prices above the current range would encourage U.S. shale producers to boost output, while a move below $40 would force those same companies to cut spending further. Another large drop in prices could also prompt big exporting countries like Saudi Arabia and Russia to further explore capping or cutting production.

While many oil companies are still struggling, the current levels offer some relief to an industry that reeled as oil fell to a 13-year low earlier this year. Fewer producers are bleeding cash, though prices are still too low for most to encourage the investment in new production that many analysts say the market will need in the coming years.

U.S. consumers and fuel-dependent industries such as airlines are continuing to reap the benefits of low fuel prices.

Because of the narrow price range, many investors appear to be taking a shorter-term approach by quickly moving in and out of oil positions to capture small gains, according to Commodity Futures Trading Commission data.

Hedge funds and other speculative investors posted their biggest-ever one-week increase in bets on lower oil prices in the week ended July 26. Then four weeks later, they cut their wagers on falling prices by the largest amount on record.

U.S. oil for October delivery settled down $1.74, or 3.7%, at $45.88 a barrel Friday on the New York Mercantile Exchange.

The oil-price collapse from more than $100 a barrel in mid-2014 to less than $30 in the first quarter of this year was a boon for trend-followers who bet on falling prices and held on for months or even years.

The current market—volatile but directionless—reflects a new era in the oil-price downturn, analysts say. Since April 8, U.S. oil prices have settled between $39.51 and $51.23 a barrel on the Nymex, the longest stretch in such a narrow range since the first eight months of 2014.

Few expect prices to drop to new lows or to rise significantly in the coming months. Economists surveyed this month by The Wall Street Journal forecast a U.S. oil price of $47.02 a barrel, on average, on the last day of 2016.

Fewer extreme moves in the oil market could be welcomed by some stock and bond investors, after two years of falling oil prices roiling their portfolios. Energy junk bonds have rebounded since the first quarter, a sign that the current price range offers some cushion for smaller producers and reduces the risk of defaults across the sector.

Still, some analysts warn that oil prices might breach the current range sooner than many think. Crude could spike higher if the Organization of the Petroleum Exporting Countries reaches an agreement to freeze or cut production, or if political uprisings or natural disasters cut deeply into supply. Crude prices could also tumble below the $40 level if new data show sharp rises in global inventories.

But for now, many investors are positioning their funds to profit from where prices have been for months.

One strategy, called “selling strangles,” uses options to wager that prices will hold within a specific range—but the trade can lead to big losses if prices move outside the higher or lower limits.