Crude Oil And Energy Stocks Suffer As Natural Gas Futures Brighten

Weekly Crude Oil Outlook

Support for crude oil futures continued to erode last week due to concerns about high supply. Technically, both Brent and West Texas Intermediate (WTI) crude oil are both headed toward bear market territory for the year as they rapidly approach a 20% correction from their 2014 highs.   

Supply concerns continue to be triggered by overproduction by the U.S., Russia and Saudi Arabia. Improvements in drilling technology are helping to drive up supply in the U.S. while Russia is most likely selling crude oil to raise cash due to the effects of the European sanctions on the country. Last week, the Saudis surprised traders by cutting prices rather than production.

With supply concerns clearly defined, demand worries may now be entering into the equation. The economic slowdown in Europe and concerns about slowing growth in China are two reasons to believe that global demand will continue to drop, leading to a further increase in supply. On October 8, the U.S. Federal Reserve complicated the supply/demand situation by expressing concerns about the rising U.S. Dollar and a global economic slowdown.

The recent rapid rise by the Greenback is a concern because crude oil is priced in dollars. With the dollar trading at a 4-year high, crude oil has become more expensive to foreign traders. This is encouraging foreigners to delay buy orders or buy only want is needed at this time.

Aggressive sellers such as hedge and commodity funds are expected to continue to press crude oil prices. There may be a few periodic short-covering rallies, but for the most part, these rallies are likely to be short-lived due to renewed selling pressure from the professionals. This should continue to produce a series of lower-highs and lower-lows on the charts as long as the bearish fundamentals remain intact.

Since demand is not keeping up with supply, it may be necessary to cut production to help stabilize prices. This is why traders will be watching for activity from the Organization of the Petroleum Exporting Countries (OPEC) for signs that the group is preparing to reduce production. If there are signs of a cut in production, traders will react quickly to adjust short positions rather than wait for the actual announcement at the next OPEC meeting in November.

The wildcard that could also trigger a strong short-covering rally is a geopolitical event. Traders continue to monitor situations in Ukraine and the Middle East for any possible disruptions in supply. Until the global economy starts to show signs of recovery to boost demand, the only help crude oil can get is if supply is disrupted.

Weekly Natural Gas Outlook

Natural Gas futures continued to consolidate inside its two month range as traders adjusted their positions to shifts in supply and changing weather patterns. Prices were under pressure most of the week due to last week's surge in supply and a warmer weather patterns in several key demand areas.

The consolidation taking place is typical for this time of year known as the "shoulder season". This is the time when the weather is neither too hot nor too cold to trigger any significant shifts in demand from consumers. At the same time, producers are trying to supply as much gas to the market as they can ahead of the winter heating season.

Last year's natural gas rally started on November 8 at much lower price levels and much higher supply levels. This year, stockpiles are about 10.1% below their levels of a year ago and about 10.5% below the five-year average. With the heating season rapidly approaching, U.S. stock piles are expected to be at about 3.55 trillion cubic feet, the lowest level since 2008, but still considered adequate. In 2013, the heating season started with 3.8 trillion cubic feet in inventory.

All of this information is adding up to a sideways-to-lower market this week unless weather becomes an issue.

Key Energy Stocks

Exxon Mobil Corp. (XOM), the country's largest producer of natural gas traded lower last week. Sellers were hitting the market due to falling natural gas prices and the general weakness in the overall stock market.

Trading at $92.76 on October 9 has the market in a position to test the low of the year at $89.25. A test of this level may encourage some professional buying, but until prices stabilize, it looks as if the stock will continue to move lower.

Even if prices stabilize, gains are likely to be capped because both rising natural gas prices and a new stock market rally will be necessary to drive the stock back toward the $100 level over the short-run. From a value standpoint, the best support area appears to be $85.00.

Traders who want to spread the risk around the energy complex should take a look at the XLE. This is a basket of energy stocks known as the Energy Select Sector SPDR, trading as one instrument.

The weekly XLE shows the energy sector in a free-fall. Currently trading at $85.84, this market is not likely to find major support until under $82.00.

Given the long-term bearish fundamentals in the crude oil market and the selling pressure in the stock market, support for crude oil and energy stocks is likely to continue to erode. Natural gas futures, however, are probably closer to bottoming due to seasonal tendencies.