Crude Oil Analysis for the Week of December 26, 2011

Last week the fundamentals clashed with the technicals in the February Crude Oil futures market and by week’s end the fundamentals clearly won. Even though the contract did not take out any significant price levels, the strong upside momentum probably gave bullish traders the incentive to continue to buy while putting fear into the short-traders and encouraging them to continue to cover their positions.

Technically, the main trend on the weekly chart remains up although momentum was clearly beginning to shift to the downside after 4 weeks of consolidation. Even the penetration of a key 50 percent price level at $95.15 as well as an uptrending Gann angle had to have had long traders on edge as the market appeared to be setting up for a retracement of the rally from $75.73 to $103.28.

The first clue that perhaps the market was not as weak as the charts indicated was its inability to break the previous week’s low at $92.70. Regaining the key 50 percent price at $95.15 and the uptrending Gann angle at $99.73 were additional clues that perhaps the selling pressure was not as strong as the chart pattern indicated.

Now that momentum has apparently shifted back to the upside, bullish traders are going to have to continue to support the market on any kind of weakness or the shorts may regain control and the downward cycle would resume. The major support area this week is a Gann angle cluster at $97.57 to $97.28. The weekly close at $99.68 was well above the cluster so unless there is a gap-lower opening this week, it looks as if the bullish formation should remain intact, allowing the market to follow-through to the upside.

If last week’s rally was fueled by strong momentum, then this week’s rally is likely to be a grinder because of a series of resistance levels. The first is the Fibonacci retracement level created by the $114.57 to $75.73 range at $99.73. This horizontal resistance level is followed by $100.28 and $101.78. Once this area is cleared, February Crude Oil will have a clean shot at taking out the main top at $103.28. A move through this level will reaffirm the main uptrend.

An optimistic outlook for the U.S. economy and a weaker U.S. Dollar helped support crude oil prices last week, but the biggest market driver was a massive decline in U.S. crude stockpiles.

Last Wednesday the U.S. Energy Information Administration reported that oil inventories fell by 10.6 million barrels to 324 million barrels. This decline represented the largest weekly drop since February 2001. At the same time, total supply reached a three-year low.

Before you conclude that a robust economy in 2012 must be in the offing, keep in mind that the massive drawdown in oil stocks may have been triggered by end-of-the-year tax activity by crude oil refiners. Even with this event factored in, the size of the drop caught many analysts by surprise as well as ill-informed short-traders. In addition, traders should keep in mind that not all of the oil that gets refined stays in the U.S. When the Dollar gets cheap, oil refined by U.S. refineries gets exported.

While a 10 million barrel drawdown is huge, traders should keep in mind that this may have been a one-time event due to an odd combination of factors. With a slight bias to the downside developing prior to the release of this bullish news, a relatively large amount of shorts had been quietly building their positions.

Since the EIA report was a surprise, the entire rally may have been driven exclusively by short-covering. The question that needs to be answered this week is how aggressive are the bullish traders willing to be as prices approach the $100 per barrel level. We may not know that answer for the first couple of days of the week, however on Thursday when the next inventory report is released, there is no doubt that both short and long traders will be paying close attention to the number.

Factors Affecting Crude Oil This Week:

Supply and Demand:  Because the Christmas holiday is going to be observed on Monday, this week’s EIA Inventory Report will be pushed to Thursday. Traders will be looking for a slight drawdown. Back-to-back double-digit drawdowns are not expected, but this news would move the market substantially.

European Sovereign Debt Crisis:  No news is good news. If conditions continue to improve or if optimism surfaces because of on-going negotiations or positive moves by the European Central Bank, look for the Euro to remain firm. A weaker U.S. Dollar is bullish for crude oil and could help to keep the market firm.

U.S. Economy:  No news is good news II. Traders just want to continue to see the U.S. economy holding steady. With the Fed signaling no new actions to prop up the economy, everything seems to be hinging on the situation in Europe.
 
Middle East Conflicts:  Always a factor because of its tendency to flair up without notice. All eyes continue to be focused on Iran and the Strait of Hormuz. In addition, the escalating situation in Syria must be watched closely. Finally, watch for deals between Libya and OPEC.

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