Weak Hands Could Limit Energy Upside After Drone Attack

The WTI contract hit a four-month high at $63.34 overnight before pulling back to the $60 to $61 trading range ahead of the Wall Street opening bell, while the SPDR Select Energy Sector ETF (XLE) rose 4% to a two-month high and is trading above the 200-day exponential moving average (EMA) for the first time since April.

The narrowly focused SPDR SP Oil Gas Exploration Production ETF (XOP) outperformed the broad-based fund, lifting nearly 10%.

Crude oil futures have posted their biggest one-day gains since the 1990s after a terrorist strike on a Saudi Arabian oil field shut down 5% of the world’s capacity over the weekend. Brent and West Texas Intermediate (WTI) contracts rose nearly 20% when world markets opened for the new trading week on Sunday evening and pulled back overnight in reaction to President Trump’s approval of a release from the U.S. Strategic Petroleum Reserve.

The oil shock will ripple through world financial markets until capacity is restored, which will likely take weeks or months, but volatility may be muted until Saudi Arabia outlines the full extent of damage and the time required to rebuild facilities. In addition, we can’t rule out a second attack because the perpetrators know the world’s excess capacity has been taken offline and may seek a more potent disruption.

Crude Oil Short-Term Chart (2017 – 2019)

WTI crude oil surged above the July high at $60.94 on Sunday night and pulled back through that level, reinforcing range resistance near the round number. Logically speaking, the buying spike did nothing to alter the mixed technical outlook because the instrument has been fully range bound since posting a six-month high in the upper $60s in April. The rally has lifted the contract just above the midpoint of that range, favoring neither bulls nor bears.

However, a secondary move is likely after the disruption’s longevity is disclosed, with an uptick targeting the April high, while a downtick would calm world markets and drop the contract into the $50s, filling the gap. For now, neither long nor short positions make sense, but a bilateral options play that profits from higher volatility could pay off nicely. Unfortunately, the options market is likely to make those put and call combinations prohibitively expensive for most traders.

XLE Short-Term Chart (2016 – 2019)

The SPDR Select Energy Sector ETF topped out in the upper $70s in 2016 and failed three 2018 breakout attempts before turning lower in the fourth quarter. It hit a 35-month low in December and bounced with other U.S. equities, reversing at the .618 Fibonacci sell-off retracement level in April. The subsequent decline found support within two points of the prior low in August, while the uptick into September has now reached within 70 cents of the July swing high.

The red line at the July peak is the price level to watch because it marks the breakdown level through the February and April 2018 swing lows in December. The fund failed a breakout above that level in April 2019, reinforcing resistance that could take more bearish catalysts to overcome. Of course, a longer disruption than expected could do the trick, as well as a second attack on oil fields.

Contrarily speaking, it isn’t wise to buy U.S. energy funds right here and hope for the best because this type of news always attracts a large crowd of weak hands who need to be punished before higher prices. As a result, volatile intraday swings and overnight gaps are likely in the next few weeks while oil and gas analysts debate the impact to U.S. energy production. Even so, the most beaten-down sub-groups, including the oil services sector, may work as value plays because they’re likely to attract less dumb money.

The Bottom Line

Crude oil and energy funds have spiked 10% to 20% in the wake of a terrorist attack on a Saudi Arabian oil field, but the event will likely attract a large supply of weak hands, lowering the odds for further upside.

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