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What's Next for Crude Oil?

By David Morrison  |  19/12/2017 14:42

”crudeoil”/
This article will focus on price action in the front month WTI contract rather than Brent. WTI tends to provide better technical signals than Brent – not always, but often enough to give a cleaner overall picture.

Price action so far

Having rallied off the sub-$28 multi-year low hit in early 2016, crude ran into a band of resistance from the end of that year to the beginning of March 2017. WTI was unable to break and hold above $54.50. It proceeded to sell off over the next few months until it hit an intra-day low just above $42 in mid-June. From here on in it staged a rally which took it up to $59 at the end of last month.

OPEC/non-OPEC output cut

Much of this move was on the back of the OPEC/non-OPEC producers’ output cut agreement. This kicked off at the beginning of 2017 when a group of producers (led by Saudi Arabia and Russia) decided to cut output by 1.8 million barrels per day (bpd). This failed to support prices early in the year (see “US shale” below). But investor opinion turned when it became apparent that compliance levels were high and that the cuts were having an impact on global inventories. Crude got a further boost in the run-up to last month’s OPEC meeting when the output cut agreement was extended from March to December 2018.

Russia unhappy

As mentioned earlier, high compliance from OPEC and non-OPEC producers helped reduce global inventories from record levels. This is something that investors will continue to keep a close eye on as we head into 2018. However, Russia has indicated that it wants to ditch the deal once inventories drop back towards the long-term average. This raises the possibility that the agreement could crumble before the official expiry at the end of next year. This could put pressure on crude prices as we get further into 2018 and approach the next OPEC meeting in June. This could prove to be an ideal forum for Russia to say that it won’t agree to anymore extensions.

US shale

But the parties subject to the OPEC/non-OPEC output cut agreement are not the only players in town. Technological advances over the last ten years have helped to make the US is the world’s third largest producer after Russia and Saudi Arabia. Thanks to shale, the US is considered to be the world’s new swing producer, with drillers ready to raise or cut production in line with supply and demand. Shale production is far more flexible than Saudi Arabia’s (the old swing producer) with US drillers able to respond to price moves relatively quickly. On top of this, the US took no part in the output cut agreement.

Estimating the break-even

For the first half of this year, the prospect of US shale companies producing millions of barrels of cheap oil helped keep a lid on crude, even as output cuts came in. There were industry forecasts saying that US production would top 10 million bpd by the end of 2017. However, that prediction proved to be overly optimistic and it’s still difficult to know where the industry’s break-even price is for crude. This will differ wildly depending on where the drilling takes place. But given the current market we can be fairly sure most is above the $40 per barrel estimated at the beginning of the year.

Speculative positioning
 
Earlier in the summer doubts surfaced over the ability of US shale producers to raise output quickly and cost-effectively.  This has been another factor in the recent increase in the price of crude. However, there’s evidence that production is picking up again with robust gains in September. If it picks up again in October which saw crude take another leg higher, then we could see traders trim back their long-side exposure. It’s worth noting that according to the latest Commitment of Traders (COT) report, speculative positioning in WTI hit a fresh record high last week. While excessive, there’s nothing to say that bullish positions can’t increase further. However, it does raise the prospect of a sudden reversal which could help to put a cap on prices, particularly should WTI close in on the $60 per barrel level.
 
Some technical levels

There was considerable excitement when both WTI and Brent surged above resistance from the beginning of the year, breaking above $54.50 and $57.50 respectively. Since early October prices have consolidated to a degree and this has led to a downturn in the standard MACD and RSI. However, the 21, 55 and 100-day exponential moving averages are all still aligned bullishly. As far as WTI is concerned, there’s some mild support around $56 while $54.50 remains significant. The current upside target is $60/62.50 – an area that acted as resistance in the summer of 2015.

Any information, analysis, opinion, commentary or research-based material on this page is for information purposes only and is not, in any circumstances, intended to be an offer of, or solicitation for, a transaction in any financial instrument. No representation or warranty is given as to the accuracy or completeness of this information. Any person acting on it does so entirely at their own risk and GKFX accepts no responsibility for any adverse trading decisions. You should seek independent advice if you do not understand the associated risks.

 

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