The squeeze higher in oil prices last week amid renewed speculation that key producers would convene to discuss potential output cuts caught many market participants by surprise especially in light of prevailing conditions in the energy sector. In spite of prices retreating from recent highs once more, there remains a growing chorus of investors, traders, and speculators expecting oil prices to rebound further from current level levels even with the multitudinous risks facing crude. Aside from high production levels that have remained high amid weak pricing, the demand side of the equation continues to show sluggish growth at very best, onshore inventories continue to fill and an ongoing price war threatens to exert undue pressure on marginal oil producers.

Buy The Rumor, Sell The News

In typical fashion, rumors hit the tape last week of an imminent meeting of major producers to discuss the potential for output cuts in an effort to help restore higher prices in crude oil. Initially, comments from Russian Energy Minister Alexander Novak appeared to show the willingness of Saudi Arabia to discuss reducing production, rumors later denied by both Saudi Arabia and OPEC, with no expectations of an emergency meeting being called. With unconventional oil production still intact despite weaker pricing, the Saudi’s will have no choice but to remain entrenched in the war for market share for longer, especially now that Iran has rejoined the energy export economy.

After years of crippling sanctions, expecting key market participants such as Iran to come to the table to discuss potential production cuts to support prices is highly suspect. The two main OPEC powers, Iran and Saudi Arabia continue to trade barbs back and forth, with on accusing the other of destabilizing the market intentionally. As such, the number of denials of the February meeting to deliberate output were enough to confirm that the rumor remains just that. Furthermore, based on the lack of action and the squeeze higher in prices during the prior week on no news, this was merely an opportunity to sell or reestablish short positons, not necessarily a turning point in the market.

Storage Capacity Running Out

Although January is typically a strong month for rising crude oil stockpiles historically, the latest figures from the Energy Information Administration took markets by surprise last week. According to the Department of Energy, onshore inventories in the United States grew by 8.383 million barrels during the week of January ended on the 19th, rising at the fastest pace in 9-months. Although stockpiles at Cushing fell during the latest measuring period, concerns remain high about the pace of additions to inventories, especially for gasoline as demand for energy continues to falter. According to the latest statistics, demand for refined distillates and gasoline fell by -14.80% and -2.50% respectively over the last 52-weeks, underlining the weakness for the outlook.

While the need to begin storing oil on floating vessels has not yet become a reality for major producers looking for a way to store excess output as they await buyers, the rapid rise in onshore storage levels could bring about the worst nightmare for producers. Inventories could prove to be the catalyst for the next major leg of momentum lower in crude oil prices as upstream producers are forced to slash prices in order to sell their supplies, creating the conditions for a sustained price war in the market. Soon it might not just be Russia facing off against Gulf producers such as Saudi Arabia, Kuwait, and Iraq in price competition, but also other OPEC and non-OPEC members keen to make sure everything pulled out of the ground was distributed.

Speculative Positions Shifting

After market participants were nearly the most short ever in the crude oil market, a surprising shift transpired, potentially marking the beginning of a reversal in crude oil prices. Net long positions largely collapsed during the sustained downside momentum felt in crude oil prices, but according to the Commodity Futures Trading Commission, through January 26thlong positions rose by 23,031 contracts. The market remained net long with short positions declining by a modest 5,444 contracts during the same measuring period. Even though many of the shorts were squeezed out by the price action higher in crude oil, this change in view does not necessarily suggest that oil is set for a sustained rally. In fact, based on market fundamentals and technicals, the exact opposite is likely.

West Texas Intermediate crude oil topped out at $34.82 last Thursday before the broad dismissal of production cut rumors sank the exuberance of the prior week of price action. From a technical standpoint, futures contracts were due for a correction after hitting new multi-year lows earlier in the month of January. However, massive speculative shorts made a squeeze higher much easier, leading to many investors exiting from positions. An equidistant channel pattern is currently emerging in the NYMEX contract with an upward bias with long positions ideally established at the lower channel line. However, based on the predominant market forces, a channel-based breakout is very likely and supported by downward tending moving averages acting as resistance. Since reopening overnight, crude has fallen over -2.00% after tumbling -7.44% in the prior session.

Major Levels Approaching

From a psychological perspective, the $30.00 price point is of great importance to sentiment. Although the “smart” money may be getting back involved at current levels to bet on a rebound, price action suggests another leg lower in prices back below $30.00 per barrel. The prevailing problems facing the sector remain unsolved as production is set to remain high while the pace of demand growth decelerates further and onshore storage capacity fills to the brim. The ongoing war for market share shows no signs of easing and Iran has made its intention’s crystal clear. With these factors intact, a medium-term rebound in prices is highly unlikely, with the short-term bounce likely already played out.