Oil prices have retreated sharply at the start of this week, with Brent dipping back towards $38 and WTI to $36 a barrel, thus giving back a good chunk of their recent gains. Up until last week, oil prices were repeatedly hitting fresh highs for the year. Just a month or so ago, they were dropping to fresh multi-year lows almost on a daily basis. The sudden turnaround had been triggered by a number of factors, including profit-taking from the sellers. Sentiment turned on investor realisation that the significantly lower oil prices boosted demand, most notably in China, and at the same time caused severe difficulties for oil producers, to such an extent that large OPEC members decided to talk with Russia about curbing crude output at January levels. Talks have been on-going for a couple of months now and so far there has been no real progress, with Iran unwilling to participate in such a deal. As it is highly uncertain that a deal to freeze oil production is forthcoming without Iran’s participation, bullish oil traders have evidently taken profit on some of their positions as after all, net long holdings in both Brent and WTI had risen strongly in recent times.
Meanwhile, drilling activity in the US has been falling and recently oil supply has also started to decline. As such, the high global inventory levels should begin to fall. So far however there’s been little evidence of that. If anything, crude stockpiles have actually risen further in the US. And there is a danger they may climb even more because of the seasonal maintenance works at this time of the year. But I think that by the start of the summer driving season, we should begin to see sharp declines in oil inventories as demand for gasoline, which is already strong for this time of the year, rises further.
Over the next couple of days, traders should watch the stockpiles data closely for crude oil and crude products, in particular gasoline which continues to find strong demand for this time of the year. But there is a risk stockpile levels could increase further over the coming weeks due to seasonal maintenance works, though essentially the market looks convinced that they will then be reduced significantly later this year, due to reduced shale output and strong demand. Our long-term view is that the potential gains for oil will be limited as US shale producers are likely to ramp up output once prices have recovered noticeably. But in the short to medium term, further gains are likely once this latest phase of profit-taking eases.
WTI oil formed a double bottom reversal pattern around the $26/$27 area in February, before breaking out of its falling wedge pattern to the upside earlier this month. It has also taken out several resistance levels, including $34.60 most recently. However, the rally has come to a halt around the old resistance area of $38.30. For now, it looks like the bears are aiming for the broken resistance at $34.60 as their next big target. Our short-term outlook would turn bearish if WTI breaks back below this support level on a daily closing basis. Until and unless that happens however, we would expect oil prices to recover and head higher once more. And if and when oil breaks $38.30 resistance then the bulls may aim for the psychological level of $40 next. This level was also previously support and converges with the 38.2% Fibonacci retracement against the May 2015 high. An eventual breakout above $40, if seen, would be deemed a very bullish outcome.
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