WTI has recently experienced one of its biggest one-month declines in several years, having lost around eighteen percent since hitting a multi-year high of $76.90 last month. There has been a perfect storm for sellers, with factors on both the supply and demand side of the pricing equation putting downward pressure on crude. However, there are indications that things are about to turn and while that high is probably out of reach for now, the bounce back should be sharp and could be very profitable.
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The supply side drivers of the drop have been twofold. First, U.S. shale production has been booming again as prices have climbed. As we found out all too well during the last bust, shale production is very price sensitive, and as WTI climbed into the $70s output also jumped rapidly. Now, though, with prices in the low $60s, it is only logical that that growth will at the very least slow significantly before long.
The other supply side issue has been more international. Part of the reason for the run up was the expectation that the U.S. sanctions on Iran would hit supply, but that worry has faded over the last month or so. That is largely because Saudi Arabia, under pressure from President Trump among others, have stepped up production to offset that. Right now, that is in their interest politically given the fallout from the Kashoggi affair, but they pushed for a production cut agreement last year for a reason and cannot afford to see prices much lower. Related: U.S. And OPEC Flood Oil Market Ahead Of Midterms
The worries on the demand side of the equation are the same as those that have caused the selloff in stocks over the last month. Ongoing trade disputes and tighter monetary policies have resulted in fears that there will be a significant slowdown in growth, both here in the U.S. and around the globe. Over the last couple of days though, the White House has given indications that a deal with China on trade is at least possible, so one of those worries should be fading. That still leaves interest rate hikes as a concern, but the Fed and other Central Banks are gradually raising rates in anticipation of an inflationary environment that would put upward pressure on oil.
An end is in sight for all these things, but they have produced an understandable short-term drop in crude. However, as the latest IEA Oil Market Report points out, both supply of and demand for oil are at historically significant peaks around 100 mb/d. That, however, is stretching the system, and spare capacity is down to 2% of global demand, which leads them to conclude that prices will be forced upwards again soon. Market dynamics indicate that when that bounce starts, it will accelerate rapidly.
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As you can see from the chart above, open interest and more importantly net positions in crude futures are at 52-week lows. The last time we were down here was in November of 2017, just before WTI began its climb from the low $50s to the high above $75.
So, we have a situation where all the things that have been putting downward pressure on crude could logically be expected to diminish, or even reverse in the near future, and market conditions that dictate that when they do the bounce will be quite sharp. That bounce may not come immediately as momentum is still strong, but traders should be looking out for any sign of a bottom forming around these levels and then use that as a basis for a risk-controlled, long-term long position.
By Martin Tillier for Oilprice.com
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