16th May - The Oil rally - Market updates

16th May - The Oil rally

18 May 2015

TECHNICALS:

Monthly Light Crude chart

The market has rallied quite sharply from the recent lows of $46.68 (June5 contract) and $50 (Aug5 contract).

The long-term chart suggests a trading range whose lower boundary is established at the lowest close in the sell-off of 2008 and whose upper boundary is established by the low at 75.15 from 2011.

Both those boundaries are reinforced by Fibonacci clusters.

We think the market would find it very difficult to break back above the 75.15 level.

Daily August 15 Light Crude chart

In the day chart note the completion of a Double Bottom whose minimum targeted move is up to 72 or so.

The bullish energy of the pattern should drive the market higher….

But the resistance above 72 that is so clear on the long-term chart should provide a good selling opportunity.

FUNDAMENTALS:

The rally in oil that began in late February has extended further and for longer than many originally thought. And, interestingly, it wasn’t started or sustained by OPEC reducing output.

In fact, the opposite is true: OPEC and especially Saudi Arabia have maintained production levels throughout.

So why the rally?

There are several factors at play here:

1.The Saudis reasoned that if they could drive the Oil price down far enough by maintaining output and adding to the glut, oil produced by fracking would become increasingly uneconomic. This would force the fracking companies to mothball their facilities which then could not be quickly re-activated.

2.The civil conflict in Yemen has worsened and drawn in other Arab states in a coalition led by Saudi Arabia. Originally an air campaign, it has evolved to include ground troops. Since Saudi Arabia and Yemen share a long border, the oil price has increased on concerns about the security of Saudi oil supplies.

3.The US has marginally reduced its own oil surplus as a result of reduced oil output from fracking.

●

So how much higher can these factors drive the oil price?

We doubt the price can go very much higher. The physical oil market tells a story of tanker loads of oil seeking a home, shipping rates subdued and the physical price falling as a result. Clearly there is a disconnect between the physical and futures markets. When that last occurred it presaged last year’s sell-off

And there are other factors to consider:

Oil fracking companies are improving their production methods. This means that the price at which fracking becomes uneconomic is set to fall. Additionally, and of greater immediate importance, is the negotiations between the major powers and Iran about her nuclear program.

Apparently, a deal is close. The deadline to reach agreement is June 30th. There appears to be a willingness on both sides to find a solution which would mean Iran resuming oil exports as a result of sanctions being lifted.

Clearly, in a market that is still over-supplied, where the leading economic blocs, the US, Euro zone, China and Japan, are all still operating at varying degrees of sub-optimal economic activity, a significant increase to the oil supply will bear down on prices. Unless that is, Saudi Arabia changes policy and agrees to reduce its own output and that of other OPEC members. That is something it has so far refused to do. It prefers to maintain market share as a priority over supporting the price.

We judge the current rally has a little further to go but our expectation is that this is a correction in a bear market, not a new bull run.

When the market turns, we expect prices to revisit the February lows, driven by in large part by Iran re-entering the oil market and US oil fracking companies finding new ways of driving down production costs.

Next story:
26th May - The UK Gilt - Is it vulnerable?

Previous story:
8th May - Sterling Euro pressures post Election

< Back to menu