Why The Sustained Bull Run On Oil Hasn’t Materialized

It is, I'm sure, puzzling to a lot of people that after hearing so much news supportive of oil prices this week WTI has failed to even break through the highs achieved a couple of weeks ago at around $47 and, if Friday morning's early action is any guide, looks set to return to where we were before the news. Just to recap, the week started with confirmation that a serious fire in Canada's oil sands region reduced Alberta's production by around 40 percent, or a million barrels a day. Then came inventory numbers that showed a surprise large draw down of crude in the U.S., and finally a bullish monthly report from the International Energy Agency (IEA) that moved from talk of the world "awash" with crude this year to "balance".

Put all that together and a serious jump in the price of crude would seem to be inevitable given that oversupply has been the real issue for a while now. We certainly saw a jump on each piece of news, but the sustained bull run that one would expect hasn't materialized, or at least not yet.

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The reason for that lies in the nature of trading. What traders set out to do is to predict the future while using the past as a guide. Technical factors, such as historical price action and previous levels of support and resistance, help to set entry and exit levels for trades, but predicting the future is about analyzing fundamentals. The price action since the middle of February that can be seen on the chart above clearly shows that that analysis has led traders to bet on higher prices for a while now, despite continued evidence that there is still a glut of oil and the failure of OPEC to do anything meaningful.

To some extent that is due to the dollar finally turning around and entering a bearish looking channel, but the biggest influence has been the stated intention of just about all oil companies to do what is necessary to survive low oil prices. They have all announced huge cuts in their E&P budgets and activities. It doesn't take a genius to work out that that should lead to a reversal of the supply and demand imbalance at some point in the future, and that made buying oil look like a good bet.

What we have seen this week from the inventory numbers and the IEA report, then, is simply confirmation that that is having an impact, but that was already priced into the market. In that context, even the loss of production following the Fort McMurray fire was seen as a temporary thing and resulted in less of a boost to crude than most would have expected. In other words the last couple of months have been a giant "buy the rumor, sell the fact" kind of pattern.

The question that traders and investors should be asking themselves, therefore, is not why did this not go up more, but rather are we setting up for another collapse? Collapse may be a bit strong, but tracking lower to at least break back through $40 again in the near future looks more likely now than powering on up to $50 and above. Sure, those cuts in E&P will have an effect, but for now the only things that have really changed point to crude moving lower, not higher.

This move up will have squeezed out an awful lot of short positions and to producers, looking back over the last year makes this look like a reasonable level to begin hedging again. In addition there is good reason to think that the dollar is about to reverse course. Polls show that the U.K. vote on E.U. membership is now extremely close, thus putting pressure on Sterling and the Euro, and a weak jobs report in the U.S. is making a Fed hike less likely. Add in the assertion from the Bank of Japan that they have lots more room to ease monetary policy and it looks as if the greenback is headed higher.

All of that, combined with a new Saudi oil minister who is not even pretending that an agreement will be reached, puts pressure on crude prices. The fact that not even a series of news items that should have been bullish could sustain WTI above $47 this week simply shows that that pressure is being felt, and lower now looks like the path of least resistance.