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No relief for Oil

19 December 2008

The Technical Trader’s view:

WEEKLY CONTINUATION CHART Oil is testing the long-term supports from the succession of prior Highs. The band of support from $33.70- $41.15 has been tested. So far it has held, but if it broke then the market would have very little support left…

DAILY CHART: The short-term picture is not encouraging for the bulls. The market has failed at the horizontal resistance from the prior low. Watch carefully for a break down beneath the recent low of $42.51. That looks likely to happen. And a test of the $39.99 horizontal will result.

The Macro Trader’s view:

The oil producers’ cartel OPEC have this week delivered the biggest output cut in their history: 2M bpd, in an attempt to stem the recent correction which saw the market more than halve since the all time high made in the summer. But far from support the market as they intended, the oil price has begun to weaken further.

In the Macro Trader’s Guide we have covered this phenomenon several times over recent weeks. As OPEC began voicing concern about the weakness of the market, several hawks began calling for a large cut in output with the aim of sending oil prices higher, towards the US$70.00 a barrel level. When producers met a couple of weeks ago they were unable to agree the size of the cut. Consequently the market weakened further and hardened up opinion in the cartel to the point where even the more moderate Saudi Arabia joined the likes of Iran demanding a big cut.

We have consistently argued that their efforts would prove counterproductive. The global economy is facing probably its worse period of weakness since the 1930’s and all the major developed and emerging economies are affected.

In an environment such as this, where demand is already weak for everything including energy, cutting output in response to price falls is simply chasing demand lower.

As we argued recently, the market corrects higher briefly ahead of the cut, driven by fear of what might occur, but as soon as the decision is known, the market refocuses back to the fundamentals; economic weakness which currently resembles gazing into a bottomless pit. Even if OPEC had proved successful and driven the price higher, the global economy would have been further damaged, resulting in greater weakness, lower energy demand and ultimately lower prices.

As it is, traders have already anticipated this affect and sent oil prices lower. Currently the driving force behind the oil price isn’t whether or not there is sufficient supply, but whether there is sufficient demand:
- with the Fed cutting interest rates to virtually zero and announcing their intention to buy bonds/print money,
- the ECB mulling whether or not to establish a clearing house facility for inter-bank and other lending, and

- the Governor of the Bank of England warning in an open letter to the Chancellor that his next official correspondence could well be explaining why inflation has dropped too low.

The authorities in these economies are clearly anticipating an extended and deep contraction of economic activity and we judge the oil price can still go lower. With China and India also suffering in this slowdown, their demand for energy has reduced too and as large manufacturing economies that rely on exports mainly to the developed economies, their appetite for oil won’t recover anytime soon.

So why hasn’t OPEC succeeded in manipulating the oil price higher? Simply because the world’s leading economies are contracting fast and traders anticipate a significant further reduction in energy demand.

Mark Sturdy, John Lewis
Seven Days Ahead

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