Crude: How much longer will the oil rally last?

Although little-changed today, crude oil looks set to end the week strongly after both contracts were able to recover from their slump at the start of the week. Yesterday’s price surge lifted Brent to its highest level since early December while WTI closed in on the 4-month high of its own that it had achieved on Monday. The London-based oil contract is now up for the third straight week while the US contract is up for the sixth. This means that oil is finding at least some support from momentum traders speculating on rising prices after the recent plunge. Some of this group of market participants may have no fundamental reason for doing so, but like most people they may be thinking that there must be a reason for prices to have rallied and so don’t want to miss out on the opportunity. Oil is finding additional support from a weaker dollar, which has sold off in part because of the rallying EUR/USD. This currency pair has found some support on the back of mostly better than expected euro zone data of late (yesterday’s PMI figures apart) and hopes that a deal between the Greek government and the Eurogroup will be reached eventually, even if the can was kicked down the road once again today. But the euro’s strength is unlikely to be sustained. Once investors make a more sober assessment of the situation, they will realise that the interest rate differential between the euro zone and US is growing, even if the probability of a Fed rate hike this year has been slashed. Thus, the dollar may not fall much further than it already has, thereby removing one source of support for buck-denominated commodities, including crude oil.

Admittedly, crude oil production in the US has started to fall back a tad and this trend may continue for some time yet given the recent sharp falls in both the oil price and also rig counts. But this will still merely represent a drop in the ocean, for the oil market is likely to remain more than amply supplied. As we reported on Wednesday, crude oil inventories in the US rose for the fifteenth consecutive time last week to a fresh record high of 489.0 million barrels. Speculators nonetheless chose to focus on the “positive” aspects of the report which showed, among other things, a 2.1-million-barrel decrease in gasoline stocks. This points to stronger fuel demand from motorists ahead of the US driving season, which unofficially starts towards the end of May. Investors are also turning a blind eye to the fact that Iranian oil could make a full return to the already-saturated market soon, after the country reached a provisional agreement with the so-called P5+1 earlier this month on a framework that would lift most of the sanctions in exchange for limits on Tehran’s nuclear programme. The possibility is thus high that any future declines in US oil production will likely be more than offset by increased output from Iran. In other words, the oil market will most likely remain sufficiently oversupplied for the foreseeable future. Indeed, the demand prospects do not look great either, with economic activity in China and the US – the world’s largest oil consumers – slowing down recently.

Nevertheless, the near-term outlook for oil is now bullish as key technical resistance levels have been broken. Until such a time we see the bullish momentum fade (soon, we suspect), the path of least resistance will thus remain to the upside. WTI is currently hovering around the 127.2% Fibonacci extension level of its most recent downswing at $57.50. A conclusive break above here may target the psychologically-important $60.00 handle next, followed by the 161.8% extension at $61.70. The key support level to watch is at $55.75 – the mid-week low. A break below this level and also the bullish trend line, would pave the way for the old resistance at $54.00. The bias would turn bearish on a potential break below $54 and the trend would be further confirmed on close below the next support at $53.00. Brent meanwhile is hovering near the 127.2% Fibonacci extension levels of the past two price swings, AB and CD, at $65.80. Should it manage to break higher then the next Fibonacci extension levels would become relevant. These are at $67.00 (161.8% extension of CD), $69.45 (161.8% extension of AB) and $70.45 (261.8% extension of CD).