6th March - How high for Oil?
09 March 2015
TECHNICALS:
Monthly Oil chart
The axis around which the oil market is revolving is clearly (and famously) the $40 level.
This was established from the Highs in 1990 2000 and the low in 2009.
The recent collapse was ( in technical terms) occasioned by the smash through $75.
The drama and important of that level was established by the cluster of Fibonacci supports there, the rising diagonal support from 1998 and the low in 2011.
After the fast move, where now is the support in the market? It is as low as $36-$38 – that band from the historic highs and lows? We think the support begins higher at the lowest close of the sell-off in 2009 around $46. In which case there is good scope for a bounce.
Daily Dollar Euro chart
But the short-term chart is sobering for the bulls - they need a break of $55 before they can get excited nor is there any clear structure within the trading range of the last two months to suggest that an early break-up is likely.
FUNDAMENTALS:
The sell-off in oil that until the end of January looked like free-fall to zero has not only paused but attempted to correct higher.
Three questions arise:
The reason for the sell-off that saw Oil prices down to multi-year lows are fairly well understood: a glut of supply caused by growing shale production mainly in the US plus persistent economic weakness in the Euro zone, China and Japan.
However, in response to the sell-off, OPEC led by Saudi Arabia, refused to cut production. The policy was clearly aimed at making shale production uneconomic so as to force the moth-balling of those facilities while at the same time maintaining OPEC market share.
To a large degree that strategy has had success. The oil price has steadied around the current level of US$50 on the futures markets. But the oil glut persists. Although there are signs of a nascent economic recovery in the Euro zone and even Japan, Chinese activity still remains sub-optimal. So why the current pause in the sell off?
Part of the reason is to do with shale production.
Although the shale production revolution turned the oil market upside down and saw the US emerge as the world’s largest producer, the process is much more expensive than traditional means of production. So when the price fell companies were quick to start mothballing shale production facilities and cut capital investment.
This has helped stabilise the oil market, because although those mothballed facilities could be reactivated, it cannot be done overnight, which means that the time lag involved has placed something of a temporary floor under the market. But rest assured, if the oil price were to rise significantly from current levels shale production would be stepped up again.
What this means in practical terms is there is not only a temporary floor under the market, but, more importantly, there is a cap above it.
We judge the upside in oil would be capped at around US$70 –US$75 a barrel with an equilibrium point some where around US$60 a barrel.
But that doesn’t mean the oil price cannot resume its slide. At this present moment other factors are also supporting oil prices. These are the unrest in Libya and the fighting in Syria/Iraq where oil fields have recently been set fire, disrupting production and supply.
Longer term, we judge shale oil production companies will seek newer technology that will lower the production costs of recovering their oil reserves and this will help drive the price lower once more.
The current period of correction could well drag on for a few more months, but we see it as just that: a correction. We still expect the oil price to fall to around US$36 a barrel on the futures market, driven in part by OPEC refusing to cut production and the US eager to maintain its new-found energy independence.
Next story:
19th March - The next bull leg of the S&P 
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26th February - Why is Dollar Euro so dull?