The inability to penetrate a major 50 percent price level at $95.13 helped form a new bottom at $95.81 on the April Crude Oil weekly chart. With two main bottoms in place at $93.27 and $95.13, momentum shifted to the upside, triggering a slight breakout above a pair of main tops at $103.08 and $104.10. This trading action reaffirmed the uptrend and has set up the market for a breakout to the upside.
A late session rally on Friday drove the market into its first upside objective at $103.59. A follow-through rally through this downtrending Gann angle is likely to take the market to the next upside objective at $108.84 this week. Although this price level is over $5.00 away, volatility has been increasing since April Crude Oil regained the $100 per barrel psychological barrier. Last week’s range was $5.04 so it is possible to generate enough buying power to reach the second objective. The difficulty may be achieving a range of this size two consecutive weeks.
While the focus was on the upside this week, traders should note that $100 .00 is new support, followed by a 61.8% price level at $99.60. Since this market has had a rapid run-up, daily traders should watch for a closing price reversal top pattern to signal a temporary top.
The Oil price surged last week after Iran reportedly warned that it would cut oil exports to six European countries including the Netherlands, Spain, Italy, France, Greece and Portugal, unless European companies agree to strike long-term agreements and guarantee their payments. The move by Iran appears to be retaliation for the European Union’s foreign ministers approval of sanction against Iran on January 23. The sanctions included a ban on Iranian oil imports and a freeze on assets.
The action by Iran hasn’t gone into effect yet, but it couldn’t have come at a worse time as many of the countries targeted are struggling financially due to the debt crisis and severe austerity measures. It now appears that the EU’s plan to punish Iran for its alleged production of military grade uranium may have backfired.
The EU’s original plan called for it to impose sanctions on Iran, but to have Saudi Arabia and other OPEC allies to increase production to cover the shortfall. This plan has backfired because now Iran appears to be calling the shots. Saudi Arabia has increased production, but political unrest in Sudan, Yemen and Syria means that demand is likely to outstrip this extra production.
When the U.S. and the EU decided to impose sanctions on Iran, they were both counting on the rest of the oil producing world to cover any production shortages. This part of the plan is pretty clear. They were also assuming that oil traders would understand the rational behind the plan. Unfortunately, they were not counting on a possible panic in the oil markets.
If the plan had unfolded as expected, oil prices would have remained relatively steady, but instead traders shifted their focus on the erosion of spare capacity. This created uncertainty in the market making traders nervous about further supply interruptions. Until the world markets can adjust to the change in supply, a nervous tone will dominate the price action.
Worries about disruptions in supply tend to cause buyers to overpay, creating volatile price swings. Prices are expected to continue to surge as long as buyers are willing to chase the market higher and nervous shorts are willing to pay anything to cover their positions. With last week’s action highlighting both of these events, one has to conclude that traders are panicking and that higher prices are to follow.
Although the fundamentals seem to be lined up for higher prices, there is still some debate as to whether Iran had followed through with its plan, or if it is only a threat at this time. This is because one news agency reported that Iran had cut exports to six European nations while another reported that Iran had only issued threats. As you can see from the price action, however, it really doesn’t matter to speculators because when issues regarding supply disruptions and oil come up, traders tend to overreact to the upside.
There is one caveat about this current rally that traders have to be aware of: this move is being driven by political maneuvers and not by true supply and demand fundamentals. Traders are pricing crude oil as if there is an actual shortage in the world market and so far this hasn’t been the case.
Keep in mind that traders are nervous about the “erosion” of spare capacity. Until this actually begins to show up in the global demand numbers, it’s all speculation. This means that in order to continue to fuel the rally, the political posturing and saber-rattling must continue or speculators will lose interest and begin taking profits.
This week’s Energy Information Administration supply and demand report revealed a decrease of 200,000 barrels in supply. The API report showed an increase of 2.9 million barrels in crude oil stockpiles while analysts were predicting a 1.9 million barrel increase. These numbers did not warrant a reaction from traders as the market soared on the geopolitical turmoil created by Iran.
The fact that the market hardly reacted to the supply and demand numbers is further confirmation that the rally is being fueled by Iranian headlines. In fact, demand has been softer this year because of weak economies in Europe and the U.S. Once the market factors in the news and refocuses on the true supply and demand fundamentals, prices are likely to retrace.
Factors Affecting Crude Oil This Week:
Geopolitical Events: Iran seems to be in control of the situation in the Middle East at this time. The European plan to place an embargo on Iranian oil seems to have back-fired causing uncertainty in world oil markets. Traders are worried about disruptions in supply which could lead to further speculative buying.
European Sovereign Debt Crisis: Last week the Euro finished a 50 percent retracement of the entire rally from January to February. This means that traders are balanced as to whether a resolution to the Greek bailout can be reached over the near-term. The Euro was headed down until late in the week when a news report sparked a strong short-covering rally. Still it looks as if big money is on the sidelines until something is resolved. With Iran dominating the news, problems in the Euro Zone are not likely to crush the oil market, but may help to trim gains.
Supply and Demand: Global demand is still soft because of weak economies in the U.S. and Europe, but traders are reacting as if there is a shortage on speculation that Iran’s ultimatum to Europe may lead to a disruption in supply.
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