Crude attempting to break higher

February 29, 2016

Crude oil prices have stormed back this week. As we go to press, Brent was trading at a good $36 per barrel while WTI was above $33.50. Both contracts have been supported first and foremost by a general improvement in risk sentiment, with equities also bouncing back buoyantly in recent days. More specific to oil, signs of a noticeable crude output decline in the US and on-going talks about an oil production freeze between some OPEC and non-OPEC countries are both helping to provide support, at least for the time being. Saudi Arabia and a few other OPEC members have reached a tentative agreement with Russia to cap their future production at the January levels. Although Iraq and Iran appear unwilling to participate in this agreement, the deal, if agreed, with or without Iraq and Iran, would still be a positive first step of coordination between large oil producing nations. According to oil ministers of Russia and Venezuela, it will be signed by mid-March.

In the US, oil production has already started to fall. But the continued declines in the rig counts, combined with significant reduction in capital expenditure and reports that some oil companies are apparently filing for insolvency, all point to a more significant output reduction there. Providing that demand growth remains healthy, all this point to a more balanced oil market later in the year. But in the short-term, oil investors are worried about the high inventory levels which show no signs of easing. In fact, the US Energy Information Administration (EIA) on Wednesday reported another 3.5 million barrel increase in oil supplies for the week ended February 19. Bizarrely, this actually provided support to prices because the official build was significantly lower than the unofficial 7.1 million barrel build that had been reported by the American Petroleum Institute (API) the day before. But for WTI to make a serious comeback there needs to be a sustained period of sharp destocking. If seen, this would be another sign that would suggest the supply glut is slowly being reduced.

And as I have said before, the price behaviour of the oil continues to point to sideways trading inside large ranges. But one thing for certain is that bearish speculators are fast running out of reasons to express their views aggressively at these still-depressed levels. For one, most of the bad news is now surely priced in – although this does not necessarily mean we won’t see further sharp price declines as the fundamental situation could easily change for worse again. For another, it could be that the oil market participants have overreacted to all this excess supply stories. The markets do tend to overplay in both directions because behind every trade is a human – or more commonly now, a machine – who are not always rational investors. So who knows, oil could reverse course and head back towards the equilibrium price – whatever level that may be, and assuming it is higher.

The charts of oil have certainly been displaying bullish characterises of late but so far neither contract has broken above their respective key resistance levels in order to confirm a change in the trend. But that could change now, for Brent is currently testing a key resistance and the top of its recent range at $36.00. A decisive break above here may pave the way for top of the bear channel around $39 and then the psychological level of $40 next. But if Brent breaks outside the bear channel, this would strongly suggest we have already seen a bottom for oil. Needless to say, a failed break at $36.00 would be bearish. WTI is likely wise looking bullish but it too remains beneath its recent range high and an established bearish trend. But could it break higher now? The momentum indicator RSI has already been trending higher for both contracts after making a series of bullish divergences. So, all oil needs now is a push which could then trigger fresh momentum buying.  But this would be the third up day in what still is a bearish trend. Usually, but not always, the third up day is when the counter-trend momentum fades. Speculators may wish to wait for oil prices to make a move then trade in the direction of the break.

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