Crude Oil Outlook
Support for crude oil futures continued to erode last week after the release of another bearish supply/demand report. Although the latest Commitment of Traders report showed speculators increased bullish bets, the size of the increase wasn’t enough to stem the decline in prices.
According to the latest weekly supply/demand report from the U.S. Energy Information Administration, crude oil inventories rose by 1.5 million barrels the week-ended December 5. This came as a complete surprise to traders who boosted long positions in anticipation of a 2.6 million barrel decline.
The latest CFTC Commitment of Traders report showed that non-commercial contracts of crude oil futures, held by large speculators, traders and hedge funds, rose to a total net position of +264,996 contracts, in the data reported on December 2. This was up 11,995 contracts from the previous report. This change represented an increase in long positions of 8,097 contracts and short position decline of 3,898.
The increase in the number of long positions was not enough to support the market as many of these new longs probably liquidated positions after the release of the bearish inventory report. This action/reaction type trading has actually been fueling the entire $40+ decline in price since June.
Non-commercial traders who continue to buy may be doing so in an effort to catch the bottom of the market, but this strategy has failed several times over the past few months. Their reliance on technically oversold signals and their inability to commit large size to the long side of the market has not been enough to overcome the extremely bearish fundamentals.
Standing in the way of a falling market with relatively small buy orders is a recipe for disaster because at some point, these weak buyers will have to sell to get out of their positions, thus perpetuating the downward spiral. In other words, in order for the sell-off to continue, someone has to “feed the bear” and these small pockets of buy orders are the ones feeding the bear.
The bull market will begin when the shorts finally decide to cover. Strong bottom-picking buying may be enough to slow down the rate of descent, but short-covering is what this market needs to put in the actual bottom. Better yet, a combination of short-covering and aggressive counter-trend buying is what is needed to trigger the start of a bona fide rally.
There is no identifiable support level on the charts at this time so the focus has to be on the price action. We will continue to monitor the chart patterns for signs of bottoming, but the key bottoming indicator will likely show up in the Commitment of Traders report. This will occur when the weakest long is finally driven out of the market and as long as there are buyers coming in each week on weak prices, then prices will likely continue to decline. To put it another way, crude oil will continue to break until the bearish traders run out of buyers to sell to.
From the fundamental side, there has to be some news or an event to chase the shorts out of the market. The biggest story will be a surprise production cut by OPEC. At this time, we have to stand by OPEC’s decision on November 27 to refrain from a production cut. We also have to respect its decision to allow the forces of supply and demand to let the market find its own support level.
Only a deviation from this decision can generate news strong enough to shake the short-sellers out of the market. So essentially, crude oil has become a news driven market which is why most technical indicators and trading systems have failed.
OPEC’s plan was to allow prices to fall in order to force U.S. producers out of the production game. It also tried to serve notice to global traders that it was not going to be the sole entity setting world oil prices. It wanted to throw the weight of controlling prices directly on the shoulders of U.S. producers. After two weeks of weaker prices, however, it looks as if U.S. producers have called OPEC’s bluff because talk is circulating that OPEC may have underestimated the financial strength of the U.S. producer.
While the Saudis may still be comfortable with the current price level, Iran, Iraq and Venezuela are not. Pressure from these countries along with Russia may finally encourage the Saudis to see it their way and make a decision to cut production. This would be the surprise news that triggers the next rally in crude oil.
If there is no news of a production cut by OPEC this week, then eventually prices will fall to a level that forces the U.S. producers to make a decision on output. This price could be $55 or even $45 per barrel. This is not improbable because prices were as low as $35 per barrel in February 2009.
Look for the “cat and mouse” production cut game to continue between the OPEC and the U.S. this week as price support continues to erode. The price action will indicate whether the short-sellers are still in control or covering. The best technical signal will be a new low followed by a higher close on big volume.