How Significant Is WTI’s Breakout?

Oil, after looking rangebound for a while, albeit at the highest levels since 2014, looks like it has broken out. When WTI futures challenged February’s high of $66.66 a few weeks ago, we reached $66.55 before retreating rapidly, a pattern that reinforced the resistance level and suggested that we would head lower again. A couple of days ago, however, we broke through and have been trading above that point for three days now. That confirms that WTI has broken out of its range, but the lack of follow through since suggests that this may not be all that significant. An analysis of the reasons for the breakout and the price action since, however, suggest that it will be.

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The first question that heeds to be answered is how significant any technical signal is in the longer term. The answer is not very. Even big-picture, clearly visible technical analysis such as this can only take you so far. The break of a level often triggers stop loss orders clustered around it, so can cause a quick jump that traders can exploit intraday, but over time more powerful fundamental forces hold sway. It is those fundamentals that forced oil higher this week.

The demand factors that have been in play for nearly a year now are well known. Improving global and U.S. growth suggest higher oil demand and the market has reacted accordingly. What changed this week, however, was the supply side of the equation. Conventional wisdom has held that that was a restricting factor for oil prices. The seeming ability of North American shale producers to turn production on and off in response to price moves suggested that the run up would prompt big increases in supply. That is still a possibility, but what changed this week was the supply picture elsewhere.

Middle East tensions and conflicts are nothing new for oil traders, nor for anyone else for that matter. They have existed for millennia and the occasional flare-ups are sometimes taken in stride by the market. The reaction to Syria’s President Assad using chemical weapons against his own people, however, has the potential to be very impactful.

There are calls for a reaction greater than the targeted strikes employed by President Trump last time and that has traders worried. There has been talk from OPEC this week about extending their production cuts into next year, but if the proxy war in Syria heats up the prospect of a unified front by the signatories to that agreement are seriously reduced. If the Vienna agreement were to break down just as U.S. shale producers are ramping up production, it doesn’t take a genius to conclude that oil will be hit hard.

All of that, however, is speculation, and if we return to the recent price action there are suggestions that the market is not worried. Even as Trump has been tweeting out contradictory signals this week and the IEA has issued a report that they expect the signatories to the Vienna agreement to declare “mission accomplished”, WTI has held above the previous highs. That indicates one of two things. Either traders are not worried about the effects should that be the case, or simply don’t believe it will happen.

Overall, then, while technical levels and breakouts are not usually too significant in the long term, the lack of volatility following the initial push upwards suggests that this one may be. We are still close enough that a drop back below $66 could come and return us to the previous range but forming a new range of around $66-$75 looks more likely.