by Pinchas Cohen
The price of oil collapsed from over $107 in June of 2014 to a shocking rock bottom of $26 and change during February 2016. Saudi Arabia started a war on market share, increasing supply with abandon at the expense of price. The biggest crude exporter in the world didn’t care that it was selling its 'bread and butter' product at at four-for-the-price-of-one rates, since its strategy was increasing its market share ahead of Aramco, it national company, going public.
The man-with-the-plan was just named heir to the Saudi throne Mohammed Bin Salman, whose father, King Salman, ousted the previous heir, the king's brother. This, ahead of the plan to take the state-owned oil company public next year, at an estimated valuation, depending on who you ask, of between $1 trillion (by market analysts) and $2 trillion (by Saudi Arabia), which would make it the world’s largest listed company, supplanting Chinese bank ICBC which has a 'paltry' $229.9 billion market cap.
The new heir, just 31 years old, was reportedly also the driver behind the OPEC production cut agreement on November 30, which pushed oil higher by $10, or 22 percent, in just over a month. Currently, however global oversupply is drowning demand, undermining OPEC’s efforts to stabilize prices.
Oil Plunges On Production Freeze Failure
Traders quickly jumped in when they realized that OPEC/NOPEC’s failure to ease the global glut is definite, as oil fell below its November 30 level, when OPEC signed its original agreement, wiping out 10 percent of its gains, as well as decimating OPEC’s efforts to control the market's oil supply.
OPEC’s cut efforts are being inundated by Libyan pumping, which is at its highest in four years, as well as an unexpected output spike by Nigeria—two OPEC members who were given exemptions from cutting supplies. Additionally, OPEC’s limit on shipments to Asia has been undermined by China, Canada and Brazil, who are filling the supply gaps. Plus US shale drillers have increased their rig count for 22 straight weeks.
Fundamentals Look Grim
From a fundamental perspective, it’s hard to see the light at the end of the downward trend tunnel when any possible rise will be met with heavy resistance given that we're now seeing the highest level of oil stored in tankers for 2017 as it's being held back in order to be sold at higher prices, as well as almost 6,000 incomplete wells across US oil fields— the most in 3 years—waiting to come on line. A rising dollar, which bottomed out in the medium-term, will add more pressure on the dollar-priced commodity.
After US shale companies improved technology and cut costs, analysts expect $40 to be the lowest price at which US companies would continue fracking, but it’s been reported that they've hedged for just such a scenario, and are guaranteed to sell for $50 irrespective of oil’s spot price. That means yet more supply.
Technicals Point To Falling Trajectory
Technically, the price of oil failed a massive reversal H&S bottom pattern, suggesting a falling trajectory.
The July 2016 peak at $51 formed the left shoulder, the February 2016, $26 trough formed the head and the May 6 peak back at $51 peak formed the right shoulder. Then, there was another peak in October with a high of $52, which may be considered a second right shoulder, as head and shoulders patterns (H&S) are not required to be symmetrical. The same supply-demand dynamic imbues the various forms.
However, at the December 2016 upside breakout of the neckline, the lows connecting the shoulders suggested a major reversal, based upon the 16- month duration and $25 of price depth. But, after oil languished until February, only to then finally fall back into the pattern, this sealed the failure of the pattern, which in turn reflected the failure of OPEC's efforts.
The failure of the price action has been confirmed by both the MACD and the RSI. Note how, while the price declined from the August 2014 trough – the left shoulder – to the February 2016 trough – the Head – the MACD and RSI both provided a positive divergence, which was on the money, as oil bounced 100% from $26.05 to $51.57 on June 6, in just four months. The same MACD and RSI are now confirming the pattern failure.
A reversal pattern’s failure is often the prelude to a major move in the pattern’s opposite direction, turning into a continuation pattern, which implies a retreat toward the February low of $26. However, it’s almost certain that Saudi Arabia will now call an emergency OPEC session in order to do everything in its power to deepen the production cuts, till markets bleed red, not black.
The announcement will most likely provide a bounce to the price of oil, and the next agreement—depending on Saudi Arabia’s level of conviction—will most likely probably generate a short- to mid-term rally. It’s hard, though, to envision a long-term uptrend for oil, when it seems like the US is working so effectively against it.
Trading Oil's Descent
The price of oil has been trading within a falling channel on the 4-hour chart since June 24. Traders may rely on this pattern till a breakout, and then steer their trades accordingly.
Conservative traders would wait on a short until the price corrects to the top of the channel and confirms its resistance with a bearish formation, to the initiated, a lower close, while placing a stop-loss above the channel, $44.25 at this angle. A safer stop loss would be above $44.69, yesterday's high before the plunge, while the ultimate stop loss would be above of $45.27, which has confirmed that the support of the previous trough on June 8 has turned into resistance.
Moderate traders would wait for a return to the high of yesterday’s bounce at $43.76, placing a stop loss above it, or above those mentioned in the previous paragraph.
Aggressive traders might short immediately, relying upon the resistance of the previous support, confirmed by yesterday’s $43.76 resistance, while they place a stop loss above it, or above any of the aforementioned positions, as they understand that their price target should be considerably more than their stop-loss, for a successful money management system. A classic risk-reward ratio is 3:1. Amateurs make the mistake of cutting their wins and running with their losses, while pros know that they need to run with their wins to cover previous losses and make a profit on top, or they’ll never beat the math and lose money, irrespective of how good their analysis is.