Crude sell-off pauses but outlook is bleak

After a sharp-two day decline, crude oil prices were firmer first thing Friday morning. This coincided with equity indices which were likewise firmer after a vicious two-day sell-off. Thus, one reason behind oil's rebound was the slight reduction in risk aversion, probably as a result of short sellers booking profit ahead of the weekend. Another reason could be due to technical reasons with Brent bouncing off the $80 handle, which had been a significant resistance level since mid-May until late September. Yet a third reason could be due to stronger commodity prices across the board, with gold, silver and copper all showing relative strength in recent days. The common denominator behind the firmer metal prices is the US dollar, which yesterday fell for third consecutive day against a basket of foreign currencies following Trump's criticism of the Fed and soft US consumer inflation readings for September. But the greenback was higher on Friday morning when this report was written, so it remains to be seen how dollar-denominated commodities will respond later on. Also, it is very much possible for stock indices to go down again once Wall Street opens for trading – similar to what happened yesterday, when the initial bounce in futures faded after the cash markets opened. So, we won't be surprised if oil prices were to resume going lower along with stock prices later today.

In any case, recent fundamental developments have been far from being positive for crude oil.

The International Energy Agency (IEA), for one, has revised downwards its forecast for oil demand growth in 2018 and 2019 by 110,000 barrels per day to 1.3 million b/d and 1.4 million b/d, respectively. The group has blamed the emerging market currency crisis as one of its main reasons behind the revised outlook. "For many developing countries, higher international prices coincide with currencies depreciating against the US dollar, so the threat of economic damage is more acute," said the IEA. This comes on the back of raised trade tensions between the world's largest economies with the US and China imposing import tariffs on each other. The dollar has risen partly because of fears the tariffs are pushing up import costs, leading to higher inflation and therefore more rate hikes from the Federal Reserve in the months ahead. A stronger dollar has made it more expensive for some large emerging market consumer nations – such as Turkey – to import the black gold.

On top of this, non-OPEC supply looks set to rise further. The US Energy Information Administration (EIA) has this week revised its forecast for US oil production significantly higher. Indeed, even the OPEC itself believes that non-OPEC supply is set to rise even more. The cartel has therefore revised its forecast for the call on OPEC in 2019 downwards by a good 270,000 to 31.8 million barrels per day. In fact, the OPEC produced more oil in September than was needed anyway. Its production climbed to 32.8m bpd in September, more than offsetting the falls in Iranian and Venezuelan oil output. At 32.8m bpd, the OPEC is therefore currently producing about 1m bpd more than it thinks will be required in 2019. So, when Iran's oil exports fall further when new US sanctions take effect next month, there's already ample supply to offset this. In terms on non-OPEC supply, it is the US where the additional supply is likely to come from, where crude oil production climbed to a record level of around 11.2 million barrels per day last week, according to the US Department of Energy.

Brent bounces of $80 support but could it break lower anyway?

As mentioned above, Brent bounced off the $80 handle this morning, which had been a significant resistance level throughout the summer. Technically, a rebound here makes perfect sense given that this level has not been re-tested – at least not on a daily time frame, anyway – since that breakout in late September. Where does it go from here is the key question now. If in the coming days, Brent oil falls below $80.00 on a daily closing basis then this would be a bearish outcome, particularly if it also breaks the last low prior to the latest breakout at $78.25. If that were to happen then we wouldn't rule out an eventual drop all the way down to low $70s and possibly even lower. However, for as long as $80 holds, the bulls will remain largely in control, although they will now face some short-term headwinds around $81.30 (already tested today) and $82.40. These levels were formerly support, and so may act as resistance going forward.