It Won’t Take Much To Drive Oil Prices Lower

October Crude Oil

Fundamental Analysis

Last week's comments ended with a summary stating that crude oil is in a news driven market and that fresh news will be necessary to drive the volatility and the price action. The key underlying story for a bullish scenario remains the possibility of an early production cut by OPEC.

This week's inside move on the weekly chart suggests investors are still waiting for bullish news. The inside move typically indicates investor indecision. It also indicates impending volatility.

The major market players remain on the short side. They will continue to defend the long-term downtrend on the weekly chart until they are overwhelmed by massive short-covering and that isn't likely to occur unless OPEC actually cuts production.

Speculative buyers appear to be willing to support the market on breaks. They may be willing to do this as long as the OPEC news is still out there. In the meantime, they seem to be content with buying the dips rather than chasing prices higher. Their reason for buying may be related to U.S. production cuts.

Outside factors may also be influencing the price action. Next week, the U.S. Federal Reserve will release its latest monetary policy statement. It may raise interest rates for the first time since 2009. This news can produce a two-sided effect.

Firstly, over the short-run, an interest rate hike will drive the U.S. dollar higher. Since crude oil is dollar-denominated, sellers could pressure the market on expectations of lower demand from foreign traders.

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Secondly, the Fed will only raise rates if it feels the economy is strong enough to handle it. This could mean increased demand over the long run.

In its monthly report released this week, the U.S. Energy Information Administration lowered its forecast for WTI crude prices. It expects prices to average $49.23 a barrel this year, down from a previous forecast of $49.62. It also reduced its forecast to $53.57 for 2016, versus $54.42.

The downward adjustment by the EIA shouldn't surprise anyone because crude oil has closed lower ten out of thirteen weeks. The surprise in the monthly report is the potentially bullish production forecast. According to the EIA, it expects U.S. crude oil output of 9.22 million barrels a day this year, down from a previous estimate of 9.36 million barrels. It also cut its 2016 estimate by 1.5 percent to 8.82 million barrels a day.

Technical Analysis

The fundamental scenario is being clearly reflected on the weekly crude oil chart. The upside momentum has slowed considerably since the over-reaction by aggressive speculation and short-covering to OPEC's decision to listen to complaints by its members of over-production. Since these traders are news-driven and there hasn't been any fresh news, speculators have stopped chasing the market higher and weak short-sellers have stopped covering.

When the aggressive buying stopped, the momentum shifted back down. However, crude oil found support on the idea that U.S. production would continue to decline.

According to the weekly chart, the main ranges are $65.03 to $38.51 and $62.87 to $38.51. These ranges have produced 50 percent levels at $50.69 and $51.77. These prices are resistance. Traders showed respect for these levels when the buying dried up at $50.04 the week-ending September 4.

The short-term range is $38.51 to $50.04. Its retracement zone is $44.28 to $42.91. The upper or 50 percent level at $44.28 stopped the market twice over the last two weeks at $43.89 and $43.99.

Summary

Prices are likely to continue to remain inside the $44.28 to $50.69 range this week unless the fundamentals change.

The first influence on prices will be the OPEC story. Since prices have been coming down since the $50.04 top, speculators may already be reducing the odds of a production cut before its regularly scheduled meeting on December 3. If they continue to reduce their long positions then the market will have a hard time taking out any resistance levels.

The market is likely to continue to find support at $44.28 to $42.91 if U.S production levels continue to decline. Aggressive counter-trend buyers may have caught a break this week when the EIA lowered its production forecasts since the price action earlier in the week indicated that sellers were ready to drive this market sharply lower.

There appears to be time for traders to adjust to any upside price action. It's the downside that investors should be worried about because it is not going to take much to drive this market through $44.28 with conviction due to the lingering oversupply issues.