After falling by more than 12% and after almost reaching our downside target for this quarter, crude oil is showing the first signs of stabilising. However, a weaker dollar driven by increased concerns about the US economic outlook is not, in our opinion, a strong enough foundation from a where a price recovery can be established.
During the past week Opec, the EIA, and the IEA all released their monthly updates on the outlook for global supply and demand. While there tends to be a difference in the outlooks, especially between the International Energy Agency (representing consumers) and Opec (representing producers), the trend towards rising non-Opec supply and steady demand continued.
The tightening of the global oil market that followed production cuts from the Opec-plus group last year helped support a return to backwardation. Such a situation where the first futures contract trades as the most expensive relative to the rest of the curve, supported a strong and eventually unsustainable accumulation of speculative bets from hedge funds.
The correction seen during the past couple of weeks was driven by the stock market rout and an oil market that had run out of the price-supportive news that was needed to support a speculative bet exceeding 1 billion barrels. Not least after US stocks began their seasonal climb, albeit at a slower than usual pace, and US production broke above 10 million barrels/day.
Hedge funds cut bullish bets by 52,000 lots in the two weeks to February 6. This was before selling accelerated with data covering the important week to February 13 only being available February 16 after the US close. Oil's ability to stabilise depends on the size of the reduction seen during the week where oil slumped by more than 6%. Yesterday's strong surge was driven by short-term traders covering sold positions as the dollar slumped and the US stock market rebounded after initially weakening following the miss on both CPI (higher) and retail sales (lower). A lower than expected weekly stock build also helped support the market.
Having seen all the gains since mid-December wiped out, Opec members have become alarmed at oil's inability to hold onto the $70/b level and are once again applying some verbal intervention to support the price. Saudi energy minister Khalid al-Falih, one of the key architects behind the deal to cut production, said yesterday that his preference is for overbalance, thereby implying that the cuts could be maintained for longer.
Brent crude oil managed to find support ahead of our target at $61/b, the 38.2% retracement of the June to January rally. A correction of this limited size tells us that what we have seen so far is only a weak correction within the established uptrend. Adding the fundamental overlay of rising non-Opec production and the risk to demand growth, crude oil is at best likely to settle into a range with sellers emerging ahead of resistance at $65.40/b and $66.50/b.