Commercial Short Selling in the Crude Oil Market

Andy Waldock  |

The United States is awash in domestically produced crude oil. U.S. crude oil inventories just hit a 26-year high. Heck, just last year North Dakota passed Ecuador’s production and Ecuador is a member of OPEC. Furthermore, the U.S. is expected to takeover the crown as largest global oil producer from Saudi Arabia as early as 2020. The questions that keep coming up are two-fold. “Why hasn’t the price of oil fallen and why are gas prices still so high.” The answer is simply, politics and logistics.

Forty years ago, the Energy Policy and Conservation Act was enacted. The idea was for the most part, to ban crude oil exports thus moving away from OPEC sourced production and towards primarily Texas based production during the oil crisis of the 1970’s and the OPEC embargo. While the intention was noble at the time, it is clear that the global energy production landscape has shifted. We are quickly approaching the point of energy independence. Our production is already eclipsing imports at the weekly level on a regular basis. In fact, the production growth here in the U.S. has helped to equalize a global production decline in each of the last three years.

This is where the loophole in the Energy Policy and Conservation Act comes into play. While crude oil itself can’t be exported, refined petroleum products can. Therefore, the oil refining companies have had access to both domestic and global markets for the last 40 years while the actual drillers have been handcuffed by an outdated policy. The oil drillers, held captive by legislation have seen the value of U.S. crude oil decline compared to the world market as domestic supplies have increased. The refiners have used the oversupplied domestic situation to their advantage. They’ve been buying domestic oil on the cheap and reselling the refined petroleum products at elevated global market prices. Score one for the refining industry.

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Ironically, altering outdated legislation may not even be necessary to equalize prices. The primary glut is confined to the Midwest. Canadian oil comes in through the Keystone pipeline along with North Dakota and Montana’s. It all ends up in Cushing, Oklahoma. Pipeline expansion would deliver this light sweet crude to more refineries, which would balance out the difference between the east and west coasts versus Midwest gas prices. Pipelines like the Gulf Coast Pipeline Project, the Houston Lateral Project and obviously, the Keystone expansion could double the Gulf Coast refining capacity and help bring West Texas Intermediate (WTI) prices back inline with the Brent crude global benchmark.

Alarmists have used the previous example to illustrate that gas prices would rise, “throughout the American heartland.” However, it’s very easy to see the population shifting from the American heartland to the coasts. Lifting the export ban would certainly lower the price of Brent crude, which would be a huge benefit to coastal refiners, which already import and refine heavier Brent crude, as well as their general populations. The simple answer is that it would create a more efficient global market and an efficient market lowers prices for everyone involved. Thus, the refiners will be the loudest voice of protest.

The embedded bias in the domestic crude oil market that has been exacerbated by the boom in the fracking industry creates a peculiar set of trading biases. Fear in the crude oil market is always measured in surprise price spikes. This can be measured by commercial traders’ (refiner) buying locking in future supply. Commercial traders were huge buyers on the 2007-2008 rally and were also the biggest sellers at the top. Therefore, it is prudent to note that their current position is the least bullish since August of 2005. We’ve used this bias to trade the short side of the discounted WTI contract for years. You can see our typical chart setup for commercial short selling in WTI crude, here. 

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not necessarily represent the views of Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to:


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