Where Further Upside For Oil Comes From

What did we learn about the crude oil market this week?

On the bearish side of the equation, we learned that according to the U.S. Energy Information Administration, crude oil inventories rose for the eighth straight week to a record 520.2 million barrels.

We also saw the U.S. Dollar soar, making dollar-denominated crude oil more expensive for foreign buyers, which could lead to lower demand. This factor could exert even more pressure before mid-month because traders have driven up the chances for a Fed rate hike at its next meeting on March 15 to about 70 percent. If the Fed hikes then crude could feel more pressure.

On the bullish side of the equation, we found out from Reuters that OPEC boosted already strong compliance with the cartel's six-month agreement to 94 percent in February.

We also know that hedge and commodity funds are sitting on record long positions. This sounds bullish, but the price action this year suggests they are accumulating positions on the dips, and are reluctant to buy strength. This may indicate that they are willing to buy low and sell high, but aren't too interested in buying high and selling higher.

If you need a comparison, think of the current rally in the stock market. This is a momentum driven rally because investors have been willing to buy high and sell higher.

Using basic math, I think the market has been trading in a range because U.S. production has been off-setting OPEC's cuts. The key variable this week was the strength in the U.S. Dollar. This is probably one key fundamental to watch in the upcoming weeks because of the strong possibility of the Fed rate hike.

However, what I find most interesting about the 94 percent compliance figure is that the United Arab Emirates, Iraq and Russia have not been fulfilling their pledge to cut output. On the other hand, Saudi Arabia has cut more than it pledged. It seems like since it's essentially their deal, they will do anything to make it work.

At the end of this week, all things being equal, I can build a case for a weaker market if the dollar continues to strengthen. Losses are likely to be limited, however, because there is still the chance that the three laggards - the UAE, Iraq and Russia - will quickly catch up with their pledged targets. This is the wildcard that could send the market sharply higher over the near-term.

Technical Analysis

Weekly June West Texas Intermediate Crude Oil (Long-Term)

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We're rolling into the June contract because we want to be able to take advantage of longer-term set-ups that may be developing. The month-to-month rotation just doesn't do it for me.

The two-year weekly chart is out best long-term chart. From this, we're able to see a top at $66.70 and a bottom at $36.18. The 50% to 61.8% retracement zone of this range comes in at $51.44 to $55.04. The June contract is trading inside this range. I think the chart speaks for itself with the tremendous amount of activity inside or near this range.

It is essentially the long-term pivot zone. Simply stated, a sustained move above the range will indicate strength and below the range will signal weakness. Holding inside the range will indicate investor indecision and impending volatility. However, we don't know how long we are going to have to wait before the volatility shows up.

Weekly June West Texas Intermediate Crude Oil (Short-Term)

One short-term range is $57.95 to $52.86. Its retracement zone is $55.41 to $56.01. This zone has provided resistance for several weeks. This week's price action suggests that sellers have once again successfully defended this zone, preventing the market from moving higher. Now traders are gearing up to test another short-term retracement zone.

The next short-term range is $46.25 to $57.95. Its retracement zone is $52.10 to $50.72. This is the primary downside target. This zone also straddles the major 50% zone at $51.44.

I have to conclude that since the main trend is up according to the weekly swing chart, a move into $52.10 to $50.72 is going to attract buyers.

Weekly June West Texas Intermediate Crude Oil (Main Trend)

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The main range is formed by the January 2016 bottom at $36.18 and the January 2017 top at $57.95.

If $50.72 fails as support then look for the start of a steep break because this move could shake the hedge funds out of the market in a big way. If this occurs then we could see a break back into the retracement zone at $47.07 to $44.50. This zone represents value so buyers are likely to step in on a test of it.

Conclusion

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Since the main trend is up and OPEC compliance is growing, we're leaning to the upside at this time. We've already seen that the hedge funds aren't buying strength so we anticipate they'll continue to buy dips and the best value area to buy is $52.10 to $50.72.

We'll also be looking for a catalyst and this is likely to be increased compliance from the UAE, Iraq and especially Russia.