Traders are betting big on an oil rally…
Last Monday, about 274,000 call option contracts traded on Brent crude oil. That surpassed the previous high in 2015—when oil was about $38 a barrel.
Call options are some of the most speculative plays you can make in the market. Speculators buy them on a security (like stocks) or commodity (like oil) when they anticipate prices will go much higher.
In this case, traders expect another large move up in oil… and quickly.
Of those nearly quarter-million call options trading, 28,000 will profit only if oil rises above $100 per barrel in the next six months. That includes 10,000 betting Brent will top $110 by the end of November.
If oil prices don’t rise to those levels, all of those call options will expire worthless… and these traders will feel plenty of pain.
As of Wednesday, Brent crude traded around $85. So these traders expect as much as a 30% rise in the next two months. That makes $110 a bold—and risky—prediction.
At the Daily, we like to follow the smart money… but we don’t like to make high-risk bets. Today, we’ll show you a safer way to play rising oil prices.
First, let me explain why we expect oil prices to go up…
Increasing Demand, Decreasing Supply
Bank of America Merrill Lynch forecasts oil to reach $95 per barrel next year. And JPMorgan Chase just dropped its bearish view in favor of higher prices in the short term.
And at a recent energy conference in Singapore, at least three energy investment firm executives said we could see $100 oil very soon.
These oil bulls have two main reasons for expecting higher oil prices: increasing demand and decreasing supply.
First, there’s demand…
As we’ve stated before, the U.S. economy is firing on all cylinders. And when things are going well, we need lots of oil.
People drive more, fly more, and buy more. All of that requires more fuel. According to the U.S. Energy Information Administration (EIA), domestic oil usage rose 2.4% this year.
And it’s not just Americans using more oil. Demand is surging in emerging markets like China and India, too.
A recent report by energy consultancy firm Wood Mackenzie predicts emerging markets will require 16 million more barrels of oil every single day by 2035.
All of this demand comes at a time when oil-producing countries are running at full tilt…
And few new oil projects have been funded lately. By the end of 2018, analysts predict that spending on expanding oil drilling will have declined by over 60% from 2014.
Eventually, oil wells dry up… And when they do, it’s unclear if there will be enough new oil available to meet demand.
Meanwhile, geopolitical uncertainty could reduce supply even further.
In August, President Trump reimposed sanctions against Iran because of its nuclear program.
Iran is one of the world’s largest oil producers, and the sanctions could take up to 2 million barrels of oil per day offline… or about 2% of global oil supply.
On top of that, Venezuela’s oil production has plummeted in recent years.
Over the past two years, the EIA estimates that Venezuela’s oil production dropped from 2.3 million barrels per day to 1.6 million barrels per day. And the EIA predicts further declines as Venezuela’s economy continues to implode.
Geopolitical concerns are the main worry of many players in the oil markets. And we don’t think other foreign producers can make up for this supply decline.
As we told you in April 2018, U.S. shale producers are pumping out more oil than they can transport. It’s going to be a while before that bottleneck gets unplugged.
Meanwhile, President Trump wants the Saudis to ramp up supply… But it’s unclear if they’ll be able to.
Saudi Arabia has said it could raise output from 10.4 million barrels per day to 12 million barrels per day. That would make up for the slack from Iran. But Saudi sources recently told The Wall Street Journal that 11 million barrels per day is already a stretch…
This Signal Says Oil Could Go Even Higher
If demand continues to increase and supply doesn’t catch up, we’ll see oil prices rise—specifically, that of Brent crude.
(It’s important to note the distinction between Brent crude and West Texas Intermediate (WTI). WTI comes from North America. U.S. oil production is already running at max capacity. So the gain will come from companies that sell Brent crude.)
One way to play this trend is through the SPDR S&P Oil & Gas Exploration and Production ETF (XOP).
And we’re already getting buy signals…
Each morning, Palm Beach Trader editor Jason Bodner runs his proprietary “early detection system” to find quality stocks pushed higher by unusually high levels of institutional buying. And XOP is showing up on his radar.
Here’s what Jason wrote in Monday’s Chart Watch …
Usually when crude goes up, so do oil exploration stocks. Right now, I’m looking at the SPDR S&P Oil & Gas Exploration and Production ETF (XOP). This fund holds many smaller companies which are leveraged to the price of oil.
The unusual volume indicator saw a bit of buying in energy names the last few days. That bodes well for XOP.
Jason continued with, “Any positive headlines or a breakout in crude could send it a lot higher from here.”
If you want a safer way to play the coming oil boom, consider XOP. We’ll leave the risky call options to the speculators.
Analyst, The Palm Beach Daily
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