Crude oil plunges 5 per cent

July 6, 2016

Crude oil prices have plunged today with Brent and WTI both shedding around 5 per cent each at the time of this writing. Crude prices have dropped this sharply because of several reasons. You have the dollar strengthening, risk aversion rising because of the ongoing Brexit saga and then there is the actual supply and demand aspects to consider on top of all this.

Genscape, for example, expects to see a 230 thousand barrel build at Cushing this week. It remains to be seen if Genscape will be proven correct: the official crude oil data from the EIA will be released on Thursday, a day later than usual because of the Independence Day in the US on Monday. The impact of temporary supply outages are waning and production from various regions that had been affected are coming back online, such as Nigeria where crude output rose in June following repairs to infrastructure that had been damaged by militant attacks, according to a Bloomberg survey. In addition, the sharp decline in the rig counts have ended and in recent weeks they have generally been rising. Although it will still take weeks before this potentially translates into an actual rise in US oil output, the markets, being forward-looking, are starting to price that possibility. Indeed, net long positions were reduced sharply in the week to 28 June. According to CFTC, they were reduced by 28,000 contracts for WTI. Data from ICE shows a similar reading for Brent: they were down some 20,000 during the same period.  

There is an element of speculative selling pressure too, especially with WTI making a couple of lower highs recently as it failed to hold above the $50 handle after several failed attempts. Consequently, the technical outlook on WTI is no longer bullish in the short term.

As far as the longer term outlook is concerned, we continue to think oil prices will consolidate in a range between $50 and $70 in the second half of this year due primarily to strong demand further reducing the supply surplus. In terms of the long-term technical outlook, well the 200-day moving average for WTI is pointing higher now and the 50-day SMA is likewise rising, while major support levels such as $42/43 are still intact. So the longer-term outlook is still bullish. Indeed, WTI could be forming a bullish flag pattern on its daily chart, which is a bullish continuation formation. So things could change very quickly in the coming days or weeks. Bearish speculators, selling because of strong downward momentum near the lows, will need to be wary about the prospects of a short-squeeze rally.

Like WTI, Brent has broken below its own bullish channel now and is likely to head towards and test the prior reference point and support at $47.00 soon. A closing break below that level, if seen, could potentially pave the way for an eventual drop towards the 200 MA at $42.50/65 area. But like WTI, both the 50 and 200 MAs are pointing higher; this tells us objectively that the longer term trend remains bullish and that what were are seeing now could be a mere correction before another potential rally.

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