USO: In Spite Of Trade Talk Optimism That Pushed Crude Future Prices Higher, Oil Markets Remain Oversupplied

ETFS



Source: Stanford Earth

Investment thesis

Since our last publication on the United States Oil Fund LP (USO), our bearish recommendation on the ETF has not materialized, with the underlying advancing 7.22% to $11.8 per share. Going forward and in spite of this advance triggered by the optimism of a nearing agreement between the U.S. and China on trade, crude markets remains oversupplied, as U.S. reserves advance in a steeper surplus.

Besides, crude demand growth is still on a downward path and although, trade talks between the world’s biggest oil consumers are expected to deliver a positive result later this month, investors remains cautious for the time being, amid multiple fake heads seen in the months long trade negotiation.



Source: Tradingview

U.S. crude oil reserves accelerate their surplus and crude exports plunge, indicating that the complex might be nearing a pullback

Crude oil storage in the U.S. advanced slightly during the October 18-25 period, up 1.32% (w/w) to 438.9m, reinstating their build after a short break witnessed last week. In the meantime, Cushing stockpiles lifted moderately, up 3.54% (w/w) to 46.03m barrels, recording the fourth consecutive weekly advance.

With these advances, crude storage seasonality lifts slightly more, establishing 3% or 12 849k barrels above last’s year level and increasing its 5-year surplus to 2.3 or 9 746k barrels.



Source: EIA, Oleum Research

More worryingly and in spite of refining utilization rates advancing 2.93% (w/w) to 87.7% over the corresponding period, signing the end of the maintenance season, stocks continue to increase, indicating that demand for the crude blend weakens.



Source: EIA, Oleum Research

Additionally, the import-export balance deteriorated considerably over the week, amid dipping domestic crude exports, down 9.67% (w/w) to 3.33m barrels and surging net imports, up 55.01% (w/w) to 3.37m barrels. That being said, these developments should bring downward pressure on crude futures and on its proxy, USO shares.

Source: EIA, Oleum Research

Besides, the spread between Brent and WTI continued to tighten in the past weeks, reaching $4.03 per barrel in the beginning of November, indicating that the American benchmark is overbought compared to its European counterpart, as Brent/WTI spreads averaged $6.28 per barrel in the last 20-weeks.



Speculator positioning



Source: CFTC

According to the latest Commitment of Traders Report, published by the CFTC and covering the October 15-22 period, speculators lifted moderately their bets on Nymex crude oil futures, up 2.6% (w/w) to 366 172 contracts, posting the second consecutive weekly advance.

While this increase has been mainly attributable to moderate long accumulations, up 2.34% (w/w) to 548 951 contracts, fresh short accretions, up 1.81% (w/w) to 182 779 contracts partly offset it.

With that, the sentiment of speculators is still bullish and bets are slightly skewed to the upside. Indeed, long positioning represents 26.38% of total open interest versus a 20-week average of 25.53%. Besides, bulls are now overweighing bears by 3.6x, providing tailwinds for crude futures and USO shares.

Since the beginning of the year, net spec bets on Nymex crude futures lifted 32.09%, whereas USO’s YTD performance climbed 7.62% to $11.3 per share.

In spite of the preliminary trade agreement between the U.S. and China expected to be signed later this month, crude oil demand growth is still down, weighing on USO shares

Going forward and in spite of recent trade developments between U.S. and China, which are working towards signing a preliminary agreement to resolve the trade war that has contributed to slow global growth and demand for the crude commodity, investors remains cautious for the time being, following the multiple head fakes seen in trade talks before.

Besides, according to the crude oil weekly cumulative composition shows that while aggregate supply edged slightly lower, crude oil demand steadied, but is still on a declining path. Indeed and since the beginning of July, demand growth weakened, providing renewed headwinds on the complex and on its proxy, USO shares.



Source: New York Fed

Concomitantly, the WTI future curve moved into a comfortable contango pattern on short-term deliveries, while edging significantly higher compared to October pricing. That being said, the roll-yield becomes unfavorable for crude oil futures and USO shares.

Closing thoughts

With crude oil reserves in the U.S. entering a deeper surplus, following the slim stockpile advance seen last week, headwinds should continue to blow over crude oil futures and USO shares.

Concomitantly and in spite of net spec positioning advancing moderately over the period and talks between the U.S. and China expected to deliver a preliminary agreement on trade later this month, skepticism continues to weigh on crude pricing.

That being said, we reiterate our bearish view on the ETF and believe that the trade optimism seen this week, uncertainty is still prevailing and that the months long trade war quarrel is far from done.

We look forward to reading your comments.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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