Oil, or rather the price of WTI, is at a critical level. Lower U.S. production numbers this week have given the black stuff a boost and pushed it back to challenge the resistance level just above $60 for the third time since falling below the mark in December of last year. It is an old adage of dealers that the third test of a chart point is the most important. It gives the best chance of a breakout, but if the resistance or support holds it usually signals a fairly sharp move in the opposite direction.
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In other words if this rally peters out, then a drop back down, even as far as the mid-$40s support, looks likely. That scenario is even more likely given the fundamental, big-picture outlook. Earlier this week we learned that Saudi oil exports had actually risen, indicating that OPEC still has no plans to cut production in support of the price. In addition, the fall in U.S. production may not have been what it seemed at first. Much of the drop came from established plays, such as Alaska rather than the fracking areas, and inventories stayed high despite the fall.
All in all then it seems that the supply/demand imbalance that contributed to the big drop is still in place. That might not matter so much if the dollar weakened significantly, but despite a correction over the last few weeks that looks unlikely. The fundamental factors that caused the dollar strength are still there: QE or its equivalent in Japan and Europe, and none in America, along with interest rates that are already higher than in either of those major trading partners and look set to move even higher before too long. It seems right, now, that the deeper I go, the more likely a resumption of the decline begins.
Given that, this is not the time to be adding to any positions in E&P companies. Should we fall back to below $50 soon and the stock of those companies track that move, then that will once again become a legitimate play. For now though, discretion is the better part of valor.
That doesn’t mean that investors should be sitting on their hands though. There are other companies that can continue to grow and do just fine if oil tracks back to the early year lows, or even if it does succeed in breaking higher. As I have pointed out in the past, downstream companies such as the refiners and marketers, actually see margins increase when oil prices fall. That margin increase offsets, at least to some degree, the fall in…