Oil Prices Encounter Reality

After the magical rally that transpired during the first half of the year, the rebound in oil prices following the multi-year lows reached at the outset of 2016 is looking a lot less like a rebound than a dead cat bounce in the energy market that has already found its top.The same factors that drove prices lower to begin with are once again resurfacing with the period of peak seasonal demand likely behind and not ahead.When combined with glaringly high output and only two serious drivers of demand, being India and China, there are few reasons for crude prices to stay elevated over the medium-term as evidenced by the downside risks scarily outstripping the upside potential.Now that stockpiles are once more on the rise, the stage is set for another retreat that could see prices remain at depressed levels for the second half of the year.

Onshore Storage Concerns Return

Although filling inventories were dismissed during the first half of the year as unlikely, crude oil stockpiles remain significantly higher than over a year ago when similar concerns were last raised.Rebounding production following the passage of several major supply disruptions has set the stage for a larger down-tick as producers race to find buyers for their excess output.With the temporary equilibrium found over the summer adding to the price gains after Canadian wildfires shuttered a substantial portion of oil sands operations combined with ongoing hostilities denting Nigerian production, there was some optimism that the glut would be able to correct itself.However, heightened Iranian production coupled with a slight bounce in US output has paved the way for supply to vastly exceed demand for the foreseeable future.

As the evidence shows, the supply-demand equilibrium remains elusive with supply continuing to outstrip demand in the neighborhood of 1.50-2.00 million barrels per day.While 9-straight weeks of inventory drawdowns helped cool fears of overflowing storage, US onshore inventories are climbing once more in an unsettling development for oil prices. According to the Energy Information Administration report released on Wednesday, crude oil inventories rose by 1.671 million barrels during the prior week, reversing over two months of falling stockpiles.Aside from oil, refined products are also raising fears of a glut in another area in the energy market.Expanded US refinery capacity combined with a massive increase in Chinese teapot refinery output have seen gasoline inventories rise by an additional 452,000 barrels in the latest reading, adding to market anxiety.

Throwing Gasoline on the Fire

With refined products exiting China at escape velocity considering the pace at which production outpaces domestic demand, gasoline seeking a new buyer is now be sent to global ports, including US ports and offloading facilities.  American commercial gasoline stocks are now standing at 241 million barrels, well above the maximum of the inventory range reached over the last 10-years and far in excess of levels witnessed during the same period in 2015.Now that demand is expected to slow into the second half of the year, matching seasonal factors that have been evident over the last five years, any market equilibrium is a distant hope. Considering the number of crude and gasoline tankers circling global port and waiting to offload has risen to staggering heights, all the factors are realigning for another slump in prices.

Technically Speaking

After breaking out from a multi-month consolidation in prices, oil prices are once again on the tumble and picking up momentum to the downside as evidenced by 5-straight sessions of losses.The next major level that stands in the way of a further slide is the 200-day moving averages.However, with the longer-term moving average trending downwards, any 50-day moving average crossover to the downside forms a “death cross” that will likely accelerate the momentum lower.At present, WTI prices stand at an important precipice.Any movement below this level, which marks a 38.2% Fibonacci retracement, paves the way towards the 62.8% Fibonacci level sitting at $35.83, a steep slide from present levels.Any move below this level is confirmation that the longer-term downtrend remains intact, labeling the price action during the first half of the year as a technical relief rally and not a trend reversal.

Looking Ahead

The next piece of data that will either fuel further downward momentum or reverse the slide is the upcoming drill rig count from Baker Hughes due at the end of the week.After three straight weeks of a rising number of oil drill rigs combined with the recent uptick in US production to 8.515 million barrels per day, if US production is making a comeback, filling onshore inventories threaten an accelerated pace of losses in prices.Additionally, weaker demand could conceivably create the ideal conditions for another period of price slashing among major producers to protect market share, adding to the downward pricing pressure.The only real potential driver of any significant gains in crude oil prices at this point would be another major supply disruption or demand growth during the second half of 2016 that mirrors the explosive growth witnessed in India during the first half.