Middle East Tensions Trigger Short Squeeze In Oil

U.S. West Texas Intermediate crude oil is poised to post a weekly gain with several factors contributing to this week's steep rise in crude oil prices. The buying started early in the week on the hope that a meeting between U.S. President Trump and China President Xi Jinping would lead to an eventual trade deal between the two economic powerhouses. It continued early Wednesday following the release of a better-than-expected government inventories report.

A weaker U.S. Dollar is also helping to boost foreign demand for dollar-denominated crude oil. The greenback weakened when the Federal Reserve hinted at a July rate cut. Buyers are also reacting to reports that OPEC and its allies will extend the deal to cut production, trim the excess supply and stabilize prices.

Middle East Tensions Rising

The biggest story of the week is the escalation of tensions in the Middle East after a U.S. official said one of the country's military drones was shot down by an Iranian missile. The drone was downed in international airspace over the Strait of Hormuz by an Iranian surface-to-air missile, a U.S. official said on Thursday, speaking on condition of anonymity.

The New York Times reported late Thursday that President Donald Trump approved military strikes on several Iranian targets, but surprisingly pulled back the order to launch the attacks. According to a senior White House official, the strikes were planned against a "handful" of targets.

"Planes were in the air and ships were in position, but no missiles had been filed when word came stand down," the newspaper reported, citing an unnamed senior administration official.

According to the New York Times, top Pentagon officials warned a military response could result in a spiraling escalation with risks for US forces in the region. The operation was called off after President Trump spent most of Thursday discussing Iran with his national security advisers and congressional leaders, according to AP reports.

U.S. Energy Information Administration Weekly Inventories Report

On Wednesday, the EIA reported that U.S. crude supplies fell by 3.1 million barrels for the week-ended June 14. This was the first decline in 3 weeks. Traders were expecting a 1.5 million barrel draw down.

The EIA report also showed that gasoline inventories were down 1.7 million barrels, while distillate stockpiles edged lower by 600,000 barrels last week. Traders were looking for supply increases of 1 million barrels each for gasoline and distillates.

Traders are hoping this is a sign of increased demand after a wave of negative demand forecasts hit the markets last week.

Weekly Technical Analysis

Weekly Trend Analysis

The main trend is down according to the weekly swing chart. However, two weeks of higher-highs has created a new main bottom at $50.79. A trade through this level will signal a resumption of the downtrend. The main trend will change to up on a trade through $64.03.

The main range is $74.86 to $44.46. Its retracement zone at $59.66 to $63.25 is the primary upside target. Since the main trend is down, sellers are likely to come in on a test of this zone.

The short-term range is $44.46 to $66.22. Its retracement zone at $55.34 to $52.77 is support.

Essentially, the market is trading between a pair of 50% levels at $55.34 and $59.66. This week's rally looks impressive on the daily chart, but not so much on the weekly chart. The chart pattern on the weekly chart suggests the market still has some work to do in establishing a solid support base.

Weekly Technical Forecast

Based on this week's price action and the current price at $57.67, the direction of the August WTI crude oil market the week-ending June 28 is likely to be determined by trader reaction to the short-term 50% level at $55.34.

Bullish Scenario

A sustained move over $55.34 will indicate the presence of buyers. If this can create enough upside momentum, then look for the short-covering rally to possibly extend into the longer-term 50% level at $59.66. Look for sellers to return on the initial test of this level. Overcoming this level, however, could trigger an acceleration to the upside with the next target the Fibonacci level at $63.25. This is the last potential resistance level before the $64.03 main top and change in trend point.

Bearish Scenario

A sustained move under $55.34 will signal the return of sellers. If this move generates enough downside momentum then look for a possible test of the Fibonacci level at $52.77. This is the last potential support level before the $50.79 main bottom.

Overview

The price action this week has been primarily headline driven. Since the trend is down, this means that much of the rally has been short-covering.

This is normal since the first rally following a prolonged down move is most often fueled by short-covering. If sentiment is really shifting in the market to the bullish side then look for buyers on a pullback into $55.34 to $52.77. I don't expect bullish traders to chase this market higher, so the next alternative is to buy value at a 50% to 61.8% zone.

On the other side of the coin, since the trend is down and there is nothing in the news to indicate a major shift in the fundamentals, look for renewed selling pressure on a test of $59.66 to $63.25.