Crude out of favour amid excessive supply, but oversold prices may soon recover slightly

On Thursday, oil prices bounced sharply on news Saudi Arabia had unexpectedly reduced its supply of oil in September. But the 328,000-barrel-per-day (bpd) decrease to 9.36m bpd was just a drop in the ocean. Indeed the price of Brent oil fell back earlier today before staging a late comeback. So, as the week draws to a close, Brent is hovering near the upper end of the range that it has been trading inside recently, while WTI is currently finding itself stuck around the lower half of its own consolidative range. The slight underperformance of WTI is unambiguously due to the sharp increases in US crude oil inventories that we have seen of late. According to the Energy Information Administration (EIA), oil stocks in the US climbed by an above-forecast 7.1 million barrels last week, which followed an even larger 8.9 million barrel increase the previous week. Unless crude inventories start decreasing sharply now and/or other large OPEC members begin cutting production, it is difficult to see where oil prices may find support from. As such, I am still slightly bearish on oil from a fundamental point of view, although now that prices have already fallen so much, the odds for a short-covering rally of some sort has meanwhile increased.


That said, a potential break below the recent lows may give rise to follow-up technical selling. On WTI (figure 1), traders should watch the $80 level very closely. So far, the bears have had three attempts to break down this psychological hurdle. The longer the bulls hold their ground here, the more likely it is that the sellers would reduce their positions, thereby increasing the probability of a sharp bounce towards at least the $84.40 resistance level. As can be seen from the weekly chart, there is also a Bullish Butterfly formation around $81, which further increases the chances of a bounce. Typically, this Fibonacci-based pattern leads to at least a 38.2% retracement of its CD leg. This translates to a potential bounce to around $90. But if the $80 level breaks down then WTI could drop all the way down to $77.50, which was the June 2012 low. After that the next support is at $75.00, the October 2010 low, followed by the next psychological level at $70. On Brent (figure 2), a decisive break above $87 could pave the way for a potential move towards the $90.00 or $91.50 resistance levels.