More than ever the OPEC needed a clear strategy to help shore up oil prices on Friday. But failing to even agree on an oil production ceiling, not only does this mean that the global supply glut will remain in place for a lot longer than expected, but it also brings into question the organization’s role as a cartel. Oil producing nations and companies will therefore continue to do what is in their own best interest and produce as much oil as possible in order to stay in the game and avoid losing market share. Eventually, some of the weaker producers will go out of business. This, combined with industry consolidation and stronger demand, means we are getting closer to a bottom for oil prices. But this could take at least several months as shale producers are still surprisingly resilient. In the short-term, the excessive surplus will continue to exert heavy pressure on prices, which should help to keep the potential gains in check.
Both oil contracts fell viciously on Monday and extended their declines on Tuesday. It was a continuation of the renewed selling pressure that began on Friday after the OPEC meeting. Both oil contracts formed bearish Marubozu candlesticks on Monday, which is a technical formation indicating that further losses are likely as the markets traded strongly in one direction throughout the session and closed at their lows. In other words, most of the bearish positions had remained open and the small bounce we saw earlier Tuesday was based on mild profit-taking. But in the afternoon trading on Tuesday, there was a more pronounced bounce that saw WTI momentarily turn green for the day. As there was no news out at the time, I think it was driven at least in part by profit taking after it became obvious that Brent wasn't going to hold below the psychologically-important $40 handle at the first attempt. Still, the rallies are likely to be short-lived as there's still no compelling reason for oil bulls to return aggressively. But at these levels oil is looking very cheap and I think we are very close to the low now. However I still don't expect to see significant gains given the current excessive surplus.
If Brent breaks and holds below $40 a barrel, this would be another psychological blow for the buyers, which could lead to further falls as the sellers grow more and more in confidence. But oil prices have already dropped very sharply in the space 2.5 trading days, so the selling pressure could start to at least ease going into the second half of the week, especially ahead of US oil stockpiles data on Wednesday. So there is a possibility we may see a bounce back to previous support at $42.20. But if the $40 handle breaks down then Brent may drop to the Fibonacci convergence area around $39.00 before potentially bouncing from there as the shorts take profit. The $39.00 level is also the extended point D of an AB=CD move, so it represents a Bullish Butterfly pattern, which can sometimes pin-point the exact top, and in this case, bottom.
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