Bearish fundamental factors lined up this week to fuel a sharp break by September Crude Oil futures. The week began with Greek citizens voting "no" to a list of demands from its international creditors. This brought the country closer to default on its loan with the International Monetary Fund and an exit from the Euro Zone. Also contributing to the selling pressure were a series of moves by China's central bank designed stem the country's stock market crash. These moves helped drive down global commodities markets.
Even before the week started, traders were taking about selling because of a reported increase in the Baker Hughes rig count. At mid-week, the U.S. Energy Information Administration reported another increase in oil inventories after traders had priced in an expected drawdown. This too factored into the weakness.
The crisis in Greece is punishing to crude prices because it is creating turmoil in the Euro Zone. This has helped create uncertainty and that has curtailed demand. In addition, it is the primary driver of the sell-off in the Euro. When the Euro gets weaker, the U.S. Dollar gets stronger. Since crude oil is dollar-denominated, the stronger dollar makes it more expensive for foreign buyers. This also pressures demand.
Since the situation in Greece appears to be close to ending, the focus this week will be on China and U.S. production. There are two ways the Greek crisis could end. Firstly, it could agree to the terms of the bailout by the…
Bearish fundamental factors lined up this week to fuel a sharp break by September Crude Oil futures. The week began with Greek citizens voting "no" to a list of demands from its international creditors. This brought the country closer to default on its loan with the International Monetary Fund and an exit from the Euro Zone. Also contributing to the selling pressure were a series of moves by China's central bank designed stem the country's stock market crash. These moves helped drive down global commodities markets.
Even before the week started, traders were taking about selling because of a reported increase in the Baker Hughes rig count. At mid-week, the U.S. Energy Information Administration reported another increase in oil inventories after traders had priced in an expected drawdown. This too factored into the weakness.
The crisis in Greece is punishing to crude prices because it is creating turmoil in the Euro Zone. This has helped create uncertainty and that has curtailed demand. In addition, it is the primary driver of the sell-off in the Euro. When the Euro gets weaker, the U.S. Dollar gets stronger. Since crude oil is dollar-denominated, the stronger dollar makes it more expensive for foreign buyers. This also pressures demand.
Since the situation in Greece appears to be close to ending, the focus this week will be on China and U.S. production. There are two ways the Greek crisis could end. Firstly, it could agree to the terms of the bailout by the Euro Zone and begin implementing tax and pensions reforms almost immediately. This is likely to trigger a short-covering rally in crude oil.
Secondly, it could back away from an agreement and leave the Euro Zone. This would mean moving out of the Euro and back into the Drachma. This could prove to be short-term bearish, but it may be the best long-term solution. Therefore, sellers are likely to hit crude oil on the headline news, but it may stabilize after the initial selling pressure subsides.
In my opinion, China is the wildcard because it is not experienced in cooling off the selling pressure in a falling stock market. In its effort to stem the selling pressure and stabilize its equity markets, it may have inadvertently added to the bear market in the commodities markets. Additionally, this week's moves by the People's Bank of China may have contributed to its already weak economy. Both scenarios are likely to lead to lower demand for crude oil.
You can see from the earlier comments that the threat to demand may have taken worries about excess supply off the table at least in the short-run. However, oversupply is still an issue. Saudi Arabia continues to produce more than it needs. U.S. production is also at a record high. It may even increase because the rig count indicates the number of producing wells grew. Another increase this week will suggest a trend is developing.
The price action late in the week suggests that most of the bearish news has been priced into the market. Additionally, the steep sell-off has put the market in a weak, technically oversold position. If Greece reaches a settlement with its creditors then short-covering is likely to drive crude oil higher. Will it be able to recover all of its losses? Probably not, since China is likely to continue to be a problem.
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Technically, the main trend turned down on the weekly chart when the September contract took out the swing bottom at $57.09. In addition, the selling pressure was strong enough to take out a short-term retracement zone at $57.07 to $55.33.
Last this week, buyers came in to defend the main bottom at $49.69. I don't expect this area to be tested. If there is a short-covering rally then look for sellers to come in and defend the downtrend if the market tests $55.33 to $57.07.
In summary, if Greece settles then look for a short-covering rally, but look for this move to be capped by a technical resistance level at $55.33. Good news from Greece will underpin the market, but bad news from China will keep a lid on any rallies. Therefore, we could be looking at a sideways trade this week with the market holding between $55.33 and $50.95.
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