Opinion: What Market Sentiment Says About Future Gas Prices
By Brian Milne on Feb. 16, 2017ANDOVER, Mass. -- Just ahead of the Christmas 2016 holiday, gasoline futures were trading at a June premium and poised to surpass the year’s high from May, the start of the driving season. Gasoline prices typically rally from the end of winter through spring on the expectation that demand will be greatest during the warm-weather months, and there’s a higher cost for summer gasoline because of environmentally required changes in fuel specifications.
It’s not surprising for gasoline prices to move off November lows toward the year’s end, only to decline in January and February, frequently establishing the calendar-year low with gasoline demand weakest in the first quarter. In 2016, the gasoline contract, reformulated blendstock for oxygenate blending (RBOB), which is traded on the New York Mercantile Exchange (NYMEX), established a low on the spot continuous chart Feb. 9 at $0.8975 per gallon. In 2015, the low was Jan. 13 at $1.2265 per gallon.
Here's a look at how market sentiment can indicate future gas-price moves ...
Exceptions to the trend
There have been exceptions to this trend. In 2014, nearest-delivered NYMEX West Texas Intermediate (WTI) crude futures crashed from June highs of more than $100 per barrel to a calendar-year low of $52.44 on Dec. 31. Nearest WTI futures would quickly break below $50 in January 2015, and they eventually registered a multiyear low Feb. 11, 2016, at $26.05. A similar selloff ensued in 2008 during the financial crisis.
The long downtrend from June 2014 to February 2016 was sparked by tight oil production in the United States that erased the theory of peak oil. It was exacerbated by the November 2014 decision by the Organization of the Petroleum Exporting Countries (OPEC) to abandon production quotas and instead defend market share from U.S. shale producers.
Two years later, on Nov. 30, 2016, OPEC looked to right the ship with a production quota, joined later by 11 non-OPEC oil producers. It would reduce oil production by a combined 1.758 million barrels per day from Jan. 1 through June 30, 2017. Absent this agreement, oil and gasoline prices were set for another downward trajectory, including a move below $30 per barrel.
Noncommercial traders in oil futures—also known as speculators—moved to their most bullish stance in seven months in mid-December. Because there’s no underlying hedge to manage, this trader group can move in and out of a position, with that shift identifying market sentiment.
Sentiment's sway on trading
Market sentiment is a powerful force in trading, with a bullish mindset overriding bearish fundamental factors. The opposite also holds true. The Commitment of Traders reports from the U.S. Commodity Futures Trading Commission provide this data. Anyone responsible for buying, selling and pricing gasoline, or budgeting for gasoline deliveries, would benefit from knowing the market’s sentiment.
A technical analysis of this weekly guide on sentiment can be valuable, and it doesn’t need to be overly complex. For example, just as nearest-delivered RBOB futures rallied to a six-month high settlement in late December 2016, and on the heels of a large net-long market position held by speculators, the relative strength index was showing a building overbought market. The higher the index, the greater the overbought condition. This dynamic suggests buying would taper off, or portend a market selloff.
Tying the relative strength index with a price chart using Fibonacci analysis further clarifies a market’s likely short-term direction, whether to determine the extent of a price retracement or to project a price. Retracement points are particularly useful in identifying support, a price at which buying might emerge during a downtrend, and resistance, a price at which selling might halt an uptrend.
The forward curve
Plotting the downtrend from the May $1.6664-per-gallon high to September’s $1.2668 low on RBOB’s spot continuous chart with Fibonacci retracement further highlights December’s bullishness. The market was decisively cracking through resistance at the 61.8% retracement point, with the May high now a resistance price. A move through the May high had positioned nearest-delivered RBOB futures for a run to $1.8190 per gallon.
Another chart, the forward curve, tells us the market’s structure. You can quickly identify the seasonal nature in RBOB’s forward curve. In the winter, it transitions from a contango—when futures nearest to delivery trade at a discount to deferred delivery—to backwardation in late spring, or where nearest delivered futures trade at a premium.
In late December, RBOB’s forward curve pointed to April delivery at $1.82 per gallon, coinciding with the Fibonacci price projection on the spot continuous chart. This exercise suggests the market’s fourth-quarter bullishness does have legs, and retail prices will be 20 to 30 cents per gallon above the prior year’s early spring.
Costlier gasoline could dull sales volume and potentially in-store sales. Yet the higher price is from a low baseline, and it is joined by an improved labor market and expectations for accelerated economic growth in 2017. Such insight should offer guarded guidance for retailers, with the understanding that market sentiment can and does change abruptly.