Downside Bias Emerging In Crude Futures

August crude oil futures are set to finish the week lower after an earlier rally failed to draw enough long interest to drive the market away from the retracement zone that has been providing resistance for several weeks. A close below this area on Friday will set a bearish tone for next week. This could create enough downside momentum to trigger a break into the last main bottom at $56.88. A trade through this bottom will turn the main trend to down.

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The main range is $48.71 to $64.12. If the selling pressure is strong enough to take out $56.88 then look for a break into its retracement zone at $56.42 to $54.60. This area is a value zone so investors are likely to show up on a test of this zone.

A weekly close below $60.50 will give the market a downside bias. Any rally would likely be labored because investors would have to regain potential resistance levels at $60.50 and $61.35 and a minor high at $62.22 before there would be enough strength to mount a challenge of the main top at $64.12.

Earlier in the week, crude oil was underpinned by news of another drop in the rig count. According to Baker Hughes, the U.S. crude oil rig count fell by four, from 635 to 631, in the week-ended June 19. This marked 28 consecutive weeks of falling active rigs. Over that time period, the number of producing rigs has dropped from 944 to 631 and are now at their lowest level since August 2010.

Some bullish investors are concerned that the pace of the rig count decline is too slow, which could be an indication that we are seeing the last of the declines because prices have reached a balance point. If prices begin to rise beyond the $62.00 level, some oil firms may be tempted to begin reactivating rigs. If prices begin another descent then the pace of the rig shutdown should increase.

Also helping to boost prices at the beginning of the week were a weaker U.S. dollar, expectations of another weekly inventories drawdown, and a report of a plan by the U.S. to help Europe defend against security threats from Russia.

A weaker U.S. dollar often helps support crude oil prices because crude oil is dollar-denominated. A weaker dollar makes U.S. crude oil cheaper to foreigners. This often leads to increased demand. Inventory drawdowns also help support prices because it usually means lower supply or increased demand. Finally, the report outlining the plan by the U.S. to defend Europe against threats by Russia helped support prices because the action may prevent Russia from dumping its oil onto the market.

By Wednesday, June 24, almost all of the earlier bullishness left the market even after the U.S. Energy Information Administration (EIA) released a report that showed a greater-than-expected inventory drawdown. According to the EIA, U.S. commercial crude inventories decreased by 4.9 million barrels the week-ended June 19. Traders were looking for a 1.8 million barrel drawdown.

The report of the eighth consecutive weekly drawdown was not enough to fuel a breakout to the upside, however, for two reasons. The first was the increase in gasoline inventory. The second, concern that increased oil production by Iran will add to the global oil glut.

According to the weekly data from the EIA, total gasoline inventories increased by 700,000 barrels the week-ended June 19. Total motor gasoline supplied averaged about 9.4 million barrels a day for the past four weeks, up by 4.5% compared with the same period a year ago.

Technically speaking, the current unleaded gasoline chart pattern suggests the selling may be greater than the buying at current price levels. During the week-ending June 19, sellers produced a potentially bearish closing price reversal top at 2.1371. This chart pattern was confirmed this week. If this chart pattern creates enough downside momentum, then look for sellers to target the recent swing bottom at 1.8980. A trade through this level will turn the main trend to down on the weekly chart.

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Helping to put a cap on oil prices this week, and perhaps drive them lower, were concerns that Iran could double exports within six months of sanctions and penalties being lifted. This would add to the already bearish supply glut.

Looking at the weekly crude oil and unleaded gasoline charts, both seem to be indicating the presence of sellers or the absence of buyers at current price levels. Although I don't expect a return to the lows we saw earlier in the year, it looks as if these markets may have to return to value areas in order to encourage fresh buying.

Also note that volatility has been dropping because of the sideways trading action, it could return this week so don't be caught by surprise.