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Jim Hyerczyk

Jim Hyerczyk

Fundamental and technical analyst with 30 years experience.

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Slowing Production May Hold Prices In Range

After reaching its highest level in three weeks and posting a higher close the week-ending June 12, August Crude Oil futures posted an inside move this week. Although the market is in a position to once again close higher for the week, the inability to take out last week’s high suggests yet more trader indecision.

The lack of upside momentum also suggests a possible shift in investor sentiment. Based on the short-term range of $64.12 to $56.88, it looks as if the next move will be determined by trader reaction to is 50% to 61.8% retracement zone at $60.50 to $61.35. Given the current set up on the weekly chart, a weekly close over $61.35 will be bullish and a weekly close under $60.50 will signal the presence of sellers.

For bullish traders, a sustained move over $61.35 could generate enough upside momentum to challenge the recent main top at $64.12. Taking out this top will signal a resumption of the uptrend. Two scenarios could take place if this occurs. 

(Click to enlarge)

The first scenario suggests that a breakout over $64.12 could lead to an eventual retracement into the major retracement zone at $72.75 to $78.42. The second scenario suggests a possible rally to $72.29 by the week-ending July 18.

A weekly close under $60.50 suggests a bearish scenario may be developing. If this leads to follow-through selling next week then look for sellers to go after the last swing bottom at $56.88. Taking out this bottom will change the main trend to down. Traders shouldn’t expect a hard break through this level, however, because of the retracement zone at $56.42 to $54.60. Selling pressure is likely to be labored once the market reaches this retracement zone.

According to swing chart analysis, $54.98 is also a valid downside target over the next 3 to 4 weeks. This price falls inside the retracement zone. Given the current scenario, one can conclude that buyers are likely to re-emerge on a test of $54.98 to 54.60.

The inability to follow-through to the upside suggests that investors are unwilling to buy strength at current price levels. The alternative to buying strength is to buy value. Although the chart pattern indicates the trend is up on the weekly chart, the current price action suggests investors may be more comfortable going long on a pull-back into $54.98 to $54.60 over the near-term.

Fundamentally, the drop in producing wells may have been enough to help put in a bottom, but it hasn’t slowed down the rate of U.S. production enough to encourage investors to continue to buy.

This week’s Energy Information Administration report for the week-ended June 12 showed that U.S. production output slowed to 9.59 million barrels from 9.61 million the prior week. The EIA is predicting that production will continue to fall until early next year, the decline may not be enough to trigger another breakout rally, but may be enough to hold prices in a range.

Offsetting the drop in U.S. production is the increased production by OPEC. The oil cartel is currently producing over 30 million barrels a day. As of June 5, it has decided that it will do nothing to limit supply and will continue to put pressure on U.S. oil producers to pull back on production. Recent signs point towards the cartel actually producing about 32 million barrels a day. This doesn’t bode well for crude oil bulls.

The latest EIA report showed that U.S. oil commercial crude inventories fell by 2.7 million barrels. This brought the total number of barrels to 497.9 million, still at the highest levels in 80 years. This was a bigger drawdown than estimated, but the pace of the decline is still a concern for bullish traders.

In conclusion, the fundamental outlook and the technical chart pattern, suggest a tired market. Fundamentally, U.S. production isn’t declining fast enough. Technically, this is being reflected by the inability to sustain a rally over $61.35. The slowdown in upside momentum could be a sign of profit-taking. This indicates that investors are satisfied with the market at current price levels and that they may prefer to buy breaks rather than strength.

Given this scenario, it looks as if the best strategy is to wait for a pullback into a value area like $56.42 to $54.60 before initiating new long positions. Buying strength at this time seems like a riskier proposition with OPEC continuing to produce at record levels. In addition, a rally over $64.12 is likely to encourage U.S. producers to increase output. This would only add to the huge global supply glut. This would once again set up a scenario for limited gains.

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