Back at the end of April, I set a $20 price target on the ProShares Ultra Bloomberg Crude Oil ETF (UCO). At the time, it was trading at less than $13 a share following a 1:25 reverse split that saved the fund from closing altogether.
Calling for a 50% gain wasn't necessarily popular after the oil market bottomed out, but there were indications that states were getting ready to reopen and I felt that could help ignite demand again. A general consensus that oil production needed to be cut contributed to the bullish case.
I didn't think it would hit that target in less than a month, but it did.
I also said in the original research note:
"This will undoubtedly be a slow road. I'm not calling for the return of $40 oil or anything like that, but I think a return to $25 isn't all that unreasonable."
I felt $25 oil was a reasonable target given it would take into a more balanced supply/demand situation combined with some modestly increased demand. At the time, I didn't believe that $30 oil was in the cards, but the July contract is already back to $32.
Where the price of oil heads here is mostly based on demand (although oversupply will certainly play a factor). With the economy slowly reopening in many places across the country, there are early indications that fuel demand is picking up again.
Fuel demand in the U.S. is improving after data from the California Fuels and Convenience Alliance showed that California gasoline demand rose to 30% of pre-lockdown demand in cities and 50% of previous demand in rural and suburban areas. Also, data from the Florida Petroleum Marketers Association showed that Florida gasoline demand, which had been down as much as 50% in cities, is now down about 20%.
And, of course, fuel demand will be linked to the spread of the coronavirus. If it looks like the virus is being contained and the economy continues to resume normal activities, there's support for higher prices. If reopening results in a second wave of new cases, people are likely to start staying at home again.
Right now, the trend of new cases in the U.S. is heading down, but we don't yet have enough data to conclusively show what reopening has done to new cases.
Another factor is how countries handle a resumption of previous economic activity. Places like Saudi Arabia have agreed to cut production in light of the current glut, but that tends to change quickly. If prices begin rising and the supply/demand imbalance starts to work itself out, you can bet that there will be an incentive to ramp up production again. If that happens, there's downward pressure on oil prices again.
At this point, I'm inclined to believe there's only modest short-term upside here. WTI crude prices were in the $50s pre-coronavirus and there's a tendency to believe that they will return to that level once it looks like the economy will return to normal.
Optimism is high right now, but I'm not sure it's fully justified. The market is pricing in a lot of good news and very little potential for things to turn negative again.
In the short-term, I can see current momentum carrying UCO from its current level of $21 to around $24. It's only modest upside, but it's reflective of the current rally beginning to gas out.
Conversely, I think there's some above average downside risk here. I'm not necessarily forecasting it, but a return to oil in the low $20s could carry UCO back down to its original May baseline of around $16.
Overall, I believe the risk/reward for oil has changed from bullish to neutral. It's been a fruitless effort to bet against investor optimism and Fed support. I suspect that will carry oil prices modestly higher from here, but there's increased potential for a downside shock.
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