Demand Concerns Drive Oil Markets

U.S. West Texas Intermediate oil futures are trading lower for the week, putting the market in a position to post a potentially bearish technical closing price reversal top on the weekly chart. This chart pattern typically leads to the start of a two to three week correction.

Demand Concerns Move to Forefront

Demand concerns are driving the price action this week. Although the OPEC-led production cuts remain supportive, they may not be enough to underpin prices if demand drop substantially.

Putting a lid on crude oil futures are renewed worries over U.S.-China trade relations. The growing concerns were fueled by comments on Thursday from a U.S. trade official who felt the two economic powerhouses were still far away from striking a trade deal despite recent optimistic remarks from the Trump administration, and a report that an upcoming meeting between U.S. President Trump and China's President Xi Jinping would be pushed into March.

Traders are also responding to another downgrade of a major economic region as well as dovish remarks from the Reserve Bank of Australia.

In the U.S. on Thursday, the crude oil tumbled after White House economic advisor Larry Kudlow said that China and the U.S. were still far away on striking a trade deal. Later in the session, stock weakened further after CNBC reported that the Trump-Xi meeting before the March 2 deadline was "highly unlikely."

Also contributing to this week's sell-off are negative comments from the European Commission. The EC cut its forecasts for Euro Zone economic growth this year and next on expectations the bloc's largest countries will be held back by global grade tensions and domestic challenges. The Commission said Euro Zone growth will slow to 1.3 percent this year from 1.9 percent in 2018, before rebounding in 2020 to 1.6 percent.

Early Friday, the Reserve Bank of Australia (RBA) may have telegraphed a rate cut for later in the year when it made a substantial downward to its growth forecasts in its quarterly Statement of Monetary Policy (SoMP). This also helped put a lid on crude oil prices.

Weekly Outlook

The outlook for lower demand is expected to continue to weigh on the crude oil market next week as the current theme in the market moving forward is concern over the slowing global economy. The news that Saudi Arabia reduced its output in January by about 400,000 barrels per day (bpd) to 10.24 million bpd is potentially bullish, but it is actually stale data. Traders are more concerned about demand at this time.

The may be some light at the end of the tunnel, however, for bullish traders. Some traders are saying that the Trump administration is not expected to renew waivers to sanctions against buying Iranian oil.

Crude traders will also be watching the price action in the stock market since it has been moving nearly lock-step with crude oil for several months. Stronger stocks will be supportive for prices, but another steep stock market decline will put pressure on crude prices.

Technical Analysis

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This main trend is down according to the weekly swing chart. Despite the impressive six-week rally, we have to conclude that the move was likely fueled by a combination of aggressive short-covering and speculative buying. The main trend never turned up because "real" buyers never came into the market.

While most of the rally was fueled by optimism over the OPEC-led production cuts which began on January 1 and appear to be working to trim the global supply glut, this news only dealt with the supply side of the equation. Buyers were looking for a more positive outlook on demand, but that wouldn't happen without a trade deal between the United States and China.

Renewed uncertainty over U.S.-China trade negotiations and a possible delay until early March has stripped speculative longs of their incentive to stay with the rally. This is driving this week's profit-taking and position-squaring. More importantly, it is helping to form a potentially bearish closing price reversal top, which could trigger the start of a 2 to 3 week correction.

The main range is $76.29 to $42.67. Its 50% to 61.8% retracement zone at $59.48 to $63.45 was the primary upside target. However, this week's price action indicates that unless traders are willing to buy strength, this target zone won't be reached over the near-term.

The new short-term range is $42.67 to $55.75. Its retracement zone at $49.21 to $47.67 is the new downside target. The formation of the closing price reversal top is a bearish signal. It often triggers the start of a 2 to 3 week correction. Typically, the target is a 50% to 61.8% retracement zone.

A correction into $49.21 to $47.67 may be a necessary step in bottoming process. This is because this zone represents value. Because of this, expect to see buyers come in on a test of this zone. This buying may be enough to form a secondary higher bottom.

Essentially, the short-covering rally wasn't strong enough to drive the market into the retracement zone at $59.48 to $63.45, but the selling pressure could be enough to drive crude oil into the value zone at $49.21 to $47.67. This is our downside target. Look for buyers on a pullback into this zone. If this move corresponds with positive developments over the U.S.-China trade deal then this could launch the next rally.

Fundamentally, traders will remain optimistic as long as OPEC and its allies continue to trim production. However, without demand, prices are likely to weaken over the near-term. Traders shouldn't expect to see a sustained rally until the U.S.-China deal is completed.