How High Can Oil Go?

Regular readers will be aware that once a strong move is underway, my instincts and training lead me to forego trading with the momentum and, based on the fact that nothing moves in a straight line forever, look instead for an inflection point and play the retracement. That is usually the best tactic, as once a move is well underway, there is way too much chance of you hitting the end of the move, or at least very close to it. Sometimes though, when a move is based on fundamental factors and supported by technical analysis, the potential is such that opposing the momentum would be suicide.

WTI looks right now to be a case in point. Last week, my immediate reaction to the news from OPEC was to say that, despite the announcement being greeted by a drop in oil, it was not what it seemed and would drive prices significantly higher before too long. That turned out to be the right call, but I also said in that article that I expected that jump to position us for a newer, higher range with a top at around $75. For a combination of technical and fundamental reasons I have now changed that view and will be remaining long and looking for WTI to move a lot higher.

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Let's deal with the more straightforward technical case first. The last couple of day's action has taken WTI, as expressed above by the E-Mini futures contract (QM) above, to multi-year highs. That break is confirmed by a couple of closes above the recent high, but if we expand the chart the real significance of that becomes clear.

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If we go back to June of 2014, when oil started its epic drop that eventually resulted in a seventy-five percent decline in price, it is clear that because of the severity of that crash there is no real resistance point to cause a technical reverse until around $95. Of course, that doesn't mean that we are definitely going to that level, but it does mean that there is no logical level for bears to look to as an entry point. The other aspect of the technical picture, net marketing positioning, also suggests further gains. The net long positions of managed money rose rapidly at the beginning of the year, but has been falling since February, so there are still plenty of potential buyers out there.

As I have said many times here though, technical analysis can only take you so far, especially when looking at long-term trends. What really matters there are the fundamentals of supply and demand, and some recent shifts there would also suggest that that $95 level is reachable.

I stated in that piece last week that the announced million barrel a day increase in production was a mirage. The way the increases were allocated made it certain that the proposed increases would not occur. When the subsequent meeting between OPEC and non-OPEC signatories to the original deal that cut supply concluded on Saturday, we got more of the same. Increase were allocated to countries that simply do not have the capacity to rapidly up production. That gave a concession to those looking for increases, but ensured that, as we have seen, the upward pressure on crude remained.

What has really changed this week though is that we now have a deadline for the embargo on Iranian oil. The Trump administration gave buyers of Iranian crude until November 4th to cease their purchases. When those sanctions were originally announced, there was some doubt as to how effective they would be. Most Iranian oil was exported to countries other than the U.S., but, as Reuters points out here, there is already strong evidence that those countries will abide by the embargo.

In addition, the demand outlook for oil has improved over the last week. The Chinese central bank, that had been pursuing a tighter monetary policy, showed signs of easing, while the summer driving season that typically bumps up U.S. demand got off to a strong start. There is still a risk that Trump's Trade War damages global growth significantly, but the stock market has so far concluded that this is just a temporary situation and a negotiating tactic, so it is reasonable to assume that commodities traders will work on the same assumption.

So, we now have a perfect storm for WTI. Supply restrictions elsewhere in the world are real and continuing, demand looks like picking up, and the technical situation doesn't suggest a halt for a while. There will of course be some volatility over the summer, but a move up into the $90s would come as no surprise.