Technical Analysis: Was This Just A Correction?

U.S. West Texas Intermediate crude oil plunged earlier in the week on worries that escalating trade tensions between the United States and China could hurt oil demand, and news that Libya would reopen its ports raised expectations of growing supply.

The price action was dramatic on the daily chart. It even changed the trend to down. However, while this week's movement is easily spotted on the weekly chart, there has been no change in trend and it looks like a normal 50% correction in a bull market.

What Happened?

The markets were under pressure before the regular session opening on Wednesday in reaction to the release of a new list of tariffs on China by the United States. This raised the possibility that China would retaliate by slapping a tariff on imports of U.S. crude oil. This action would substantially weaken demand for U.S. WTI crude oil.

Prices were further pressured after U.S. Secretary of State Mike Pompeo said on Tuesday that Washington would consider requests from some countries to be exempt from sanctions due to go into effect in November to prevent Iran from exporting oil.

Washington had previously said countries must halt all imports of Iranian oil from November 4 or face U.S. financial restrictions, with no exemptions. So the Pompeo announcement came as a surprise for those holding long futures contracts.

The first two events set the table for the steep sell-off, which was triggered after Tripoli-based Libya National Corp. said four export terminals were being reopened after eastern factions handed over the ports, ending a standoff that had shut down most of Libya's oil output.

Additionally, a report showed Saudi Arabia hiked its oil output in June to the highest level since the end of 2016, as it aims to cool the market after crude prices recently rose to 3-1/2-year highs.

The Fundamentals

In other news, the U.S. Energy Information Administration said on Wednesday that U.S. crude stockpiles fell by 12.6 million barrels during the week-ending July 6. This was the biggest price slide in nearly two years.

Some traders said that the inability to rally following the release of this potentially bullish news made investors think twice about playing the long side. And this triggered the steep break.

Weekly Technical Analysis

(Click to enlarge)

The main trend is up according to the weekly swing chart. A trade through $72.98 will signal a resumption of the uptrend. The main trend will change to down on a trade through $62.99.

The short-term range is $62.99 to $72.98. Its 50% to 61.8% retracement zone is $67.99 to $66.81. This zone provided support after Wednesday's steep sell-off.

The contract range is $89.40 to $40.45. Its retracement zone is $64.93 to $70.70. This zone is controlling the longer-term direction of the market.

The intermediate range is $54.96 to $72.98. Its retracement zone at $63.97 to $61.84.

Since the main trend is up, buyers are likely to continue to step in on pullbacks into these retracement levels. This type of trading will continue as long as the market remains above the main bottom at $62.99.

Forecast

Moving forward, we have to consider several factors. Firstly, if the new list of tariffs on China are eventually imposed then China could turnaround and tax U.S. oil. This could have an impact on global growth and demand.

Secondly, the recent rally was being supported partly from a drop in Libyan output. Reports show that production fell to 527,000 barrels per day (bpd) from a high of 1.28 million bpd in February following the port closures. If Libyan production can get back to its high then this will take care of some of the spare capacity concerns.

Thirdly, the new unknown is how much oil will the possible relaxation of U.S. sanctions on Iranian crude exports bring into the markets?

Fourthly, we have to continue to expect production from Saudi Arabia, Russia and the U.S. to rise. Additionally, at some time in the near future, the Canadian pipeline problem will be fixed and the supply disruption over. This will bring additional crude to the market.

Finally, on Thursday, the International Energy Agency (IEA) issued a new warning on spare capacity. The IEA warned that spare capacity may be stretched as OPEC and Russia increase production. The IEA cautioned that the world's oil supply cushion "might be stretched to the limit" due to production losses in several different countries.

We're going to see heightened volatility and two-sided traded. However, the weekly chart indicates the uptrend is still intact so this likely means buyers are going to continue to step up when support or value areas are tested. If investors continue to heed the warning from the IEA then look for support to develop.