Crude oil has been through a whole lot of drama in the last two weeks only to get back to where prices previously stood. The Saudi Arabia bombings caused a huge price shock to the markets. Events like this will typically either have long-term price ramifications for oil or they become another overreaction in the markets that quickly bring prices back to equilibrium. No doubt what happened in this case, but the markets will still be looking for direction and other factors will come into play.

Supply is the Issue for Crude Oil Fundamentals

The big picture here is that there are plentiful supplies of crude oil right now and into the foreseeable future, while demand appears to be tapering off. China and Europe are seeing slower economic growth.  In fact, I don’t see many signs of this turning around anytime soon. I see more risk to slower global economic growth than a surprise to the upside. Slowing economic growth should obviously lead to slowing demand for crude oil.

The demand side of the equation should keep oil prices from running substantially higher, as we have seen in the past. Strong growth from China, India and developing countries kept oil prices around $100 for years. It could be years before crude oil gets into that type of supply/demand situation again.

Oil production in the US is the key area of focus when evaluating the fundamentals. The US is producing oil at an accelerating pace and has the capacity to increase further.  This is a trend that is negative for oil prices, although that trend has been present for a while and prices reflect it.  The question is how much more can this drive prices lower or is it already factored in?

I see a negative on the demand side and a negative on the supply side for oil prices. Neither of those trends look to reverse in the near future in my opinion. Crude oil has been trading between $50 and $65 for most of the year. That is a sweet spot that keeps production humming in the US and keeps the consumer fairly happy. Higher prices will likely lead to more production and that will eventually weigh on prices.

Variables to Crude Oil Prices

The fundamentals will eventually determine the longer-term prices of crude oil. However, there could be variables that change this outlook. A main concern is always on the stability in the Middle East. There could be continued attacks on Saudi’s oil or Iran could do more to disrupt the markets. Right now, these forecasted types of events always carry some type of risk premium in crude oil prices. However, there is less concern in the markets with a plentiful supply situation and the ability to increase supplies. That is one of the reasons why prices retreated relatively quickly from the Saudi attacks.

OPEC could eventually come out with more cuts or the global economic situation could turn for the better. A good trade deal with China could help turn sentiment and the economies more positive. I doubt that will happen anytime soon, but it is a possibility. Or maybe all these struggling countries will try to out-stimulus one another with low/negative interest rates and printing money. That could turn the supply/demand situation more positive…at least for a while. Again, I would err on the side of these factors being less probable.

While anything could happen in the crude oil market, I believe the probabilities point to no major shifts in the outlook. And that outlook is weaker. I would look at price spikes into the $60s as an area for opportunities to sell.   

Technical Setup for Crude Oil

The main activity on the charts this month was the gap higher after the Saudi attack. All those gains dwindled and now that gap has been closed. Some technicians might consider that formation a buying opportunity. I think the market might bounce, but I see it as a negative that the market couldn’t hold ANY gains after the Saudi event. To me, that is an indication the market wants to go lower. There is a minor trendline support in this area, but minor trendlines in consolidation ranges like this typically don’t mean much.

I am also watching the low end of the range around $50 as a key support level. There will probably be some solid buying if the market gets down there. The interesting part will be whether a break of that level leads to heavy selling or a quick reversal. I would treat this market as a range bound market with a negative bias and trade it accordingly – sell at the top end and buy at the bottom end. There are also plenty of shorter term strategies for crude oil trading. Feel free to contact me to discuss some of these strategies.