For weeks, investors had been focusing on whether OPEC will extend its deal with other major producers including Russia to extend its strategy to cut production, trim the excess global supply and stabilize prices. However, the last two weeks, the major influence on the crude oil market has been rising U.S. production. This week, questions about demand have also been thrown into the equation.
If we assume that the supply and demand news is offsetting or balanced then I think we can build a strong case for prices to become balanced over the near-term. Since the rally started at $43.39 and we may have hit a top at $58.14 then it is possible that we could correct back to its 50% level at $50.77 over the near-term.
If this occurs then it may give investors a chance to reassess the fundamentals and decide if they should continue to buy, or increase the selling pressure.
Based on the news this week and the price action, I think there is a very strong possibility that crude oil will break into this price level.
Key Issues Driving the Price Action
Simply stated, there is enough evidence to conclude that the OPEC-led plan to limit production is working. However, it is moving too slowly to achieve its goal to cut supply below the five-year average in a timely manner. Therefore, it feels it needs extend the deal beyond the March 2018 deadline. This is likely to take place when the cartel meets on November 30.
The price action since June indicates that traders also believe this is a done deal which is why they have been buying futures contracts.
The rally has also been supported at times by improving oil demand and escalating tensions in the Middle East that threatened to disrupt production. Furthermore, the impact of Hurricanes Harvey and Irma also skewed the refinery numbers enough to underpin prices.
Strong hedge and commodity fund buying has also supported prices with these two entities holding near record long positions at a two-year high.
Despite the bullish outlook based on these specific fundamental factors, investors were hit with a dose of reality this week when a downbeat outlook for oil demand from a top energy watchdog and fears of rising U.S. output sparked a sell-off in crude futures.
Earlier this week, the International Energy Agency lowered its outlook for demand growth in both 2017 and 2018. The IEA reduced its growth forecast by 100,000 barrels a day for each year, projecting that oil markets will remain oversupplied in the first half of 2018.
The energy group concluded in its monthly oil report that global demand will struggle to sop up rising output by producers outside of OPEC, particularly from the United States.
Finally, U.S. drillers are pumping near all-time highs and this trend is likely to continue into 2018.
With the supply and demand stories offsetting each other, the next major move in the crude oil market will likely be decided by the hedge funds. Recent numbers from the Commodity Futures Trading Commission showed us that hedge funds have raised their bullish bets on U.S. crude to the highest level since March, while bearish positions fell to a nearly seven-month low.
Something has to give and contrary theory tells me that the long investors are vulnerable. If you follow Herd Theory, then you know that if one hedge funds start to liquidate aggressively, they’ll all start liquidating and I think this is what is going to eventually drive the market to at least $50.77.
January West Texas Intermediate Crude Oil Futures Technical Analysis
(Click to enlarge)
The main trend is up according to the weekly swing chart. However, this week’s lower-low has helped create a new minor top, indicating that momentum has shifted to the downside.
A trade through $58.14 will indicate a shift in momentum to up while a move through $58.21 will signal a resumption of the uptrend. If buyers come in strong over $58.21, we should eventually see a rally into a major 50% level at $63.95.
The downside potential is actually more interesting. The short-term range is $46.95 to $58.14. If the selling momentum gets stronger, then its 50% to 61.8% zone at $52.55 to $51.22 will become the first downside target.
The main range is $43.39 to $58.14. If the downside pressure continues over the near-term then its retracement zone at $50.77 to $49.02 will become the secondary downside target.
Combining the two retracement zones makes $51.22 to $50.77 the best downside target.
Since the main trend is up according to the weekly chart, any of these retracement levels could become support. Bullish traders will look at these levels as value. They will try to form a secondary higher bottom.
The current price action is very common in any bull market. Sometimes even in the strongest of rallies, the market will run out of buyers. This is usually fueled by investor uncertainty. Traders want clarity so they can hedge their risk, but right now they don’t have clarity.
Traders are fairly certain that the OPEC-led group will extend its deal to limit output, but they aren’t certain when it will achieve its goal of pushing stockpiles below the five-year average. This is because of concerns over rising U.S. production and worries over demand.
Given all the concerns, I think a pullback into the retracement zones is justified. I don’t think there is enough urgency to buy at current price levels. I also think the professional investors feel the same way so I’d be patience at this time and wait for a pullback into the value areas before initiating any new long positions.