The energy complex was volatile this past week, driven by outside factors and traditional fundamentals.
The week began with crude oil under pressure because of a huge sell-off in global equity markets. The catalyst behind the selling pressure was turmoil in the Chinese economy following the previous week’s release of a bearish manufacturing activity report. Investors were looking for action from Chinese officials because the selling pressure and excessive volatility suggested that no one was steering the ship.
The People’s Bank of China stabilized the markets on Tuesday when it cut its one-year lending rate and lowered the amount of reserves banks must hold for the second time in two months. It followed these actions by aggressively selling the Yuan. Like other commodities, crude oil stabilized on the news with many traders taking a “wait and see” approach.
The sideways price action also suggested consolidation leading into Wednesday’s U.S. Energy Information Administration weekly inventory report.
Late Tuesday, traders were surprised when the American Petroleum Institute weekly crude stocks fell unexpectedly last week. Its report said that U.S. Weekly Crude Stocks fell 7.300 million barrels, from -2.300 million barrels the previous week. Analysts were looking for an increase of 1.900 million barrels.
On Wednesday, the EIA report suggested that demand exceeded supply the week-ending August 21, leading to an inventory drawdown. The EIA reported a 5.45 million barrel draw. Traders were originally looking for a 1.00 million barrel increase. One can’t really call this a surprise, however, because of the big change in the API report the day before.
WTI reached a low of $37.75 earlier in the week at the same time Brent futures traded $42.23. The market became severely oversold at that time with many investors feeling that with prices this low, U.S. oil producers are highly unlikely to sustain operations. The thought at this time is that many more rigs would have to be shut down over the near-term.
At the end of the week, the fundamentals remain bearish, but the crude oil chart pattern suggests a short-term bottom may be forming. This is not expected to be “The Bottom,” but it could trigger a short-term, short-covering rally designed to alleviate some of the selling pressure.
October Crude Oil
(Click to enlarge)
Technically, the main trend is down on the weekly chart. The market began the week following an angle moving down $2.00 per week from the $62.65 top. This week, the angle came in at $40.65. Next week, it drops down to $38.65. Look for a bearish tone as long as the market remains below this angle.
This may be difficult next week, however, since as of August 27, the market was trading on the bullish side of the downtrending angle. If it sustains a move above this angle then look for the start of a short-term rally.
Before getting too excited, however, keep in mind that the previous rally drove the market up $5.33 in 2 weeks. If there is a similar move from $37.75 then the market may only rally to $43.08 over the near-term before the selling pressure resumes.
Crude oil is also in a position to post a potentially bullish closing price reversal bottom. A close over $40.45 the week-ending August 28 will create this chart pattern. This pattern often leads to the start of a 2 to 3 week rally equal to at least 50 percent of the last break.
If we were totally optimistic about the market at this time, we’d be looking for a rally to at least $50.20 by the week-ending September 19. Since the fundamentals are overwhelmingly bearish, a rally to this price is not probable. Nonetheless, short-sellers and counter-trend buyers have to be aware of the upside potential of this market.
In conclusion, the longer-term fundamentals are bearish so we expect the market to remain under pressure until the crude oil supply starts to trend lower. Technically, the market is showing signs of a short-term bottom.
If the bottom at $37.75 holds and there is a follow-through rally next week then the short-term target over the next two weeks is $43.08. If there is a dramatic change in the fundamentals and momentum makes a powerful shift to the upside then buyers are likely to take out $43.08 with conviction. This could lead to an even bigger rally.