Selling Pressure Rises As Rig Count Drop Slows

Technical and fundamental factors weighed on crude oil late in the week, which could be signaling support has been pulled from the market. On Thursday, sellers overcame buyers at a key area on the daily chart and buyers also succumbed to another bearish inventory report.

Throughout February, April crude oil futures had been range bound, trading inside the 2015 range of $44.37 to $55.05. This futures contract spent much of the month hovering around while trying to establish support at its retracement zone at $49.71 to $48.45.

Buyers made two valiant attempts to breakout to the upside, but each move failed. The current sell-off was strong enough to take out the retracement zone and a pair of bottoms, signaling renewed selling pressure. The daily chart indicates there is room to the downside since the nearest support is the main bottom at $44.37.

Three questions will be answered at the start of the new month. The first will deal with the key retracement level at $48.45. If weak sell stops were triggered when this level failed then buyers are likely to show up to defend the market. This could create enough upside momentum to regain the support zone and re-establish some of the previous bullishness.

Secondly, the selling pressure through $48.45 could be strong enough to fuel a prolonged break into the main bottom at $44.37. This move will indicate that investors are seeking value. If the market breaks all the way back to within a dollar or two of the main bottom before buyers re-emerge then this will indicate that the buyers still like the long side but would rather buy weakness instead of strength.

In the third scenario, buyers will completely abandon their quest to turn the market higher and control of the market will be recaptured by the sellers. This means that the main bottom will fail and a new downside target will be set.

The problem that remains for counter-trend buyers is the size of the output. Supply continues to grow according to the weekly U.S. Energy Information Administration. At this time, investors are having a hard time trying to figure out when the inventory is going to stop growing.

For several weeks, the drop in the rig count gave bullish traders the idea that the pace of production would come to a grinding halt because of the rate at which the rigs were being shut down. Last week, however, this pace slowed from the previous week. If the pace of the shut downs continues to soften this week then more selling pressure is likely to hit the market.

The chart pattern throughout the month represented a scenario that reflected an aggressive shut down of rigs. Since this pace has slowed, investors have had to adjust their assessments of the supply and demand situation. This is why the market is seeking a new support area.

As long as the rig count continues to drop, there is hope that new support will be established somewhere between $48.20 and $44.37. If the rig count continues to decline and production begins to taper then look for this scenario to develop over the near-term. If the rig count becomes stable but production continues to rise then look for a test or $44.37. This area could also fail.

In summary, the next move by crude oil will be determined by the size of the rig count. The most bearish scenario will feature a stable rig count and rising production. A scenario which features a drastic drop in the rig count and a tapering of production will help establish another higher bottom.

Look for volatility to increase this week as investors try to correlate the relationships between rig counts, production and demand.