Why Oil is of the boil?

Why Oil Is Of The Boil?

Why Has Oil Fallen So Sharply Detailed Report, Posted on March 31, 2015 facebook-icon

Why has oil fallen so sharply?

The decline that started in June 2014 was driven by two major factors:

1. A slowdown in global growth

2. A large glut of excess oil

At the same time as the global economy was slowing down and reducing demand for oil, the amount of oil produced was rising. The reason for the oversupply in oil is being blamed on the US. In the five years leading up to 2014, US oil production surged by 75% as new oil extraction methods, including fracking, triggered a large number of new oil fields in the US.

In contrast, production from the rest of the world, including from Opec (the Organisation of the Petroleum Exporting Countries), saw production rise a mere 5% in this period. Some production in Europe actually fell in recent years.

When will the oil glut end?

Opec, whose members include Saudi Arabia, Nigeria and the UAE, has refused to cut production during this period,preferring instead to maintain their market share. Thus, the US may have to carry the burden of the cuts. Even though the US oil rig count has fallen by 31%, it could take some months before oil production starts to decrease as oil rigs can’t be shut down overnight.

Added to this, even though the US is trying to reduce production, this could be neutralised by Iran. If Iran can reach a deal with six western nations that would see limits imposed on Iran’s nuclear capabilities in the coming days (early April), then the West may lift crippling sanctions. Some of the sanctions imposed on Iran by the West include oil exports. If sanctions are lifted, Iranian oil may flood the market, potentially causing prices to fall below the $46 per barrel in Brent and the $43 per barrel in WTI that we saw at the start of 2015.

Thus, with the outlook for global growth looking weak (China is the latest to cut its GDP forecast to 7% from 7.5% for this year), it could take some time before the supply/demand macro comes back into balance for the oil price.

Geopolitical issues:

This does not mean that oil will continue to fall in a straight line. On March 26th, news that Saudi Arabia had launched air strikes against Yemen caused a 6% surge in the price of Brent and a similar amount in WTI.

The market was concerned about the impact potential retaliatory air strikes could have on Saudi Arabia’s oil fields as well as the proximity of Yemen to the Mandeb strait that connects the Red Sea with the Gulf of Aden. This is used to transport Middle

Eastern oil exports through the Suez Canal, and is a major trading route in the Middle East. However, in the days after the launch of the attack, the oil markets had calmed down as Saudi Arabian oil fields did not appear to be threatened and the market did not believe that either side would attack the Mendab strait due to its broad-based importance to the region.

This incident may have had a temporary impact on the price of oil, but it is also a clear example of how geopolitical events can cause sharp swings in the oil price that can be painful for traders.

Will oil continue to fall?

See below for our technical view on the WTI and Brent price in the medium term. From a fundamental point of view, it is difficult to see oil changing trend any time soon because:

• There is still too much oil in the world

• If sanctions on Iranian oil exports are lifted it could have a negative impact on the price of WTI and Brent, causing another leg lower for both oil benchmarks

• Opec does not look like it will cut production anytime soon

• The US may be cutting production, but it could take some time for that to feed through and reduce oil supply

• If oil prices decline further this could speed up the oil price recovery as it may force the US to cut production at a faster

clip, and it could even force Opec to turn down the oil taps

• The oil price has, so far, been fairly resilient in the long term to geopolitical risks

Technical Outlook: WTI

Following the precipitous drop from above $100 as recently as Q3 of last year, WTI’s downtrend is taking a pause. As the chart below shows, WTI has stabilized in a $10 range between $44 to $54 for the first three months of 2015, as traders weigh the fundamental crosswinds. Midway through March, prices briefly peeked below support at $44.00, but that proved to be a false break as traders quickly stepped in to put a floor under the oil price, driving the commodity back above $50.00 in short order. This rapid reversion back to the middle of the consolidation zone suggests that traders are comfortable with the current conditions and that it may take a strong catalyst to drive rates out of the established range.

Meanwhile, the MACD and RSI indicators show that the previous bearish momentum has evaporated. For its part, the MACD has returned back to the “0” level, indicating balanced two-way trade, while the RSI has carved its own range from 30 to 60 over the last few months. Sharp traders will be watching for a breakout in the RSI over the coming weeks to foreshadow a possible breakout in WTI itself. If we see a bullish break above the top of the range and 100-day MA at $54, bulls could look to press WTI up to the 23.6% Fibonacci retracement of the entire 2014-2015 drop near $58. On the other hand, a conclusive break below the mid-March low at $42 could expose the psychologically significant $40 level next. For now though, the three-month range is the dominant feature of the chart below, and as long as that range holds, readers may want to focus on fading any near-term moves up to $54 or down to $44 for a return back toward the middle of the range.

 
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