How Much Further Oil Could Fall

It's been a relatively quiet week in the crude oil market with prices continuing to drift lower in search of a balance point. The stories driving the price action didn't change much last week. Compliance with OPEC and non-OPEC member plans to cut production, trim the global supply and stabilize prices remains intact. At the same time, U.S. production continues to remain high, offsetting OPEC's efforts.

Late in the week, the Saudis may have made a feeble attempt to spark a rally when they announced a cut in exports to the United States in March by around 300,000 barrels per day from February, but speculators didn't bite on the news.

A plunging U.S. Dollar also had a limited effect on prices despite theoretically making dollar-denominated crude oil attractive to foreign buyers.

Hedge and commodity funds likely pulled back a little on their liquidation plans. At least that is what the price action is telling us.

All-in-all, it looks as if crude traders have become content with holding prices in a range once again, but this time at much lower prices than earlier in the year. And like earlier in the year, this may mean 8 to 12 weeks of consolidation before the next major move. During this time frame, we're going to learn whether OPEC wants to extend its plan to curtail production, or if U.S. output will continue to remain steady, pushing supplies to new records.

If prices remain under pressure then this will indicate that investors are betting on increased U.S. production. If prices suddenly spike to the downside then this will indicate that investors are betting on the end of the OPEC deal. However, if there is a spike to the upside then this will mean an extension of the current deal to cut output beyond June is in the works.

A couple of OPEC members have already said they will support an extension of the plan, but it's not really up to them. If there is going to be an extension then it is going to require major cooperation from the non-OPEC membership and a few of them haven't really been compliant with the first deal.

Russia, for example, has only cut about a third of its pledged amount. It has even gone as far as saying that a recovery in U.S. oil output may deter OPEC and non-OPEC producers from extending production cuts beyond June and might lead to a new price war.

Barring a few short-covering rallies, it looks as if lower prices are here to stay. The market is likely to find a few support zones at which prices will consolidate, but overall, I can see prices moving lower until the low prices begin to affect the profitability of U.S. producers.

Technical Analysis

Weekly June West Texas Intermediate Crude Oil Analysis

(Click to enlarge)

Once again, I feel the best way to analyze crude oil is to study the retracement zones rather than overbought/oversold indicators, moving averages or even trend lines. This is because of the market's tendency to produce price swings.

The major retracement zone that is providing the best long-term resistance and the zone that essentially prevented the market from rallying for nearly 13 weeks is $55.04 to $51.44. The market straddled the upper-end of this zone at $55.04 for several weeks before plunging to the lower level at $51.44.

The market didn't spend a lot of time at $51.44 before the sellers overcame this level with enough force to trigger sell-stops and to fuel massive liquidation by the hedge funds. Therefore, like the old adage says, "old bottoms are likely to become new tops". This being said, I now consider $51.44 the key resistance level.

June crude oil should maintain a downside bias unless the buying is strong enough to overcome $51.44. Even if this price is taken out, we can't even begin to call this market bullish until $55.04 then $57.95 are overtaken.

The 52-week range is $36.18 to $57.95. Its 50% to 61.8% range is $47.07 to $44.50. This zone is the primary downside target. Inside this zone are previous bottoms at $46.25 and $44.56. I expect to see prices consolidate inside this zone over the near-term until acted upon by a major force.

This major force is likely to be a news event regarding the OPEC production-cut deal. While prices are consolidating inside the $47.70 to $44.50 zone, OPEC is either going to confirm an extension of the deal, or it is going to announce the end of the deal.

Prices could stabilize over $47.07 if there is an extension, or they could collapse under $44.50 if the deal comes to an end. As you can see from the weekly chart, there is plenty of room to the downside under $44.50 with potential targets coming in at $41.32 and $36.18. Any move over $47.07 is likely to be labored.

In conclusion, this week, we could see a move into $47.07 to $44.50. Be careful selling weakness into this zone because we could see profit-taking and consolidation. I don't think there will be a lot of new shorting this close to a potential support zone so the key is to avoid getting caught in a trap.

Once the market reaches $47.07 to $44.50, just sit back and wait for fresh news about an extension. Trader reaction to this zone will determine the longer-term direction of prices.