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Oil price pulls back – where to now?

With Brent topping $80 a barrel, and US Crude hitting levels not seen since November 2014, it seemed inevitable a pullback in oil prices was likely. Last week provided the perfect opportunity for a cool off, with an unexpected US inventory build of 5.778M barrels and talk of increasing production by Russia and Saudi Arabia.

The build may well have been a red herring since it appears to have been caused by higher crude imports against lower exports, with US production remaining flat. The US inventory build dampened bullish spirits, but the real drenching came by way of news that Russia and Saudi Arabia are discussing a rise in oil production by up to 1m barrels a day (mb/d). With inventory levels now below their 5-year average and the oil price recovery more than sufficient for the majority of oil producing company’s and countries this move looks to be about cooling off the recent stampede in pricing rather than plugging any major deficit in supply.  While the Saudi’s wanted oil at higher levels to facilitate the floating of Saudi Aramco, equally they are hearing the displeasure from the US about the effect a high oil price is having on their economy – it appears a happy medium could be achieved in the $60-70 range for Crude. On the flip side of the coin, there is the possibility that the US will continue to increase its oil production, plugging much of the supply deficit if given the opportunity.

In a report earlier this month, the International Energy Agency (IEA) stated oil demand growth for 2018 had been revised slightly downwards, with the average for the year now expected to be 99.2 mb/d. This is just above global supply levels reported in April of around 98 mb/d, so an increase up to 1 mb/d appears about right to achieve equilibrium.

 

A look at the weekly chart for Crude Oil futures shows the price has dipped from highs of nearly $73 to $66.5 as I write – the price action has been forming a clear upward trend channel since the lows of early 2016.

Crude appears to have bounced off several levels of indicated support today. First, there’s a diagonal (purple) trend line that runs from June last year, having been touched a number of times since. Second, the price action has (so far) bounced sufficiently to remain above recent peaks of January and March. And thirdly the 20 Weekly Moving Average (MA), which has been tested a number of times this year has remained intact. Should this support zone fail, from a technical perspective I believe a test of the $60-62 is the worst-case scenario. This area is not only a key psychological number but also a key zone for oil to hold above. A move below $60 would open up the possibility of further drops towards $50 which are surely unlikely all the while oil is in its current point in the boom-bust cycle and potential threats to supply still exist.  I have also added another trend line of defence (dotted purple) which has been hit a number of times over the past couple of years – this might offer support around $64 should it be needed.

Taking a look at the current Commitment of Traders (CoT) for Crude Futures reveals a significant reduction in long positions this month, but the differential between the longs and shorts is still extremely large with short positions virtually unchanged.

While seasonal fluctuations suggest it is likely inventory draws will resume shortly, the increased likelihood of production increases from Russia and Saudi Arabia do go some way to counteract Bullish bets on further climbs in the oil price. This, in turn, may result in further profit-taking by speculators. There’s still significant geopolitical risk out there following the prospect of US sanctions on Iran and the crippling of Venezuela’s oil output, but a return to $100 oil is looking less likely this week than last.

Whatever the movements in spot prices, the majority of oil companies have had to adapt to lower oil prices over the past couple of years, drastically cutting costs and investment. The extent to which this may cause a supply shortage due to lack of investment remains to be seen, but at present, with lower cost bases and potentially increased revenue from higher oil prices, equity holders in the sector have good reason to remain optimistic about the recovery in the near-term.

Author: Stuart Langelaan

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