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Crude oil price declines provide attractive long-term value

Crude prices has started to regain ground after sharp coronavirus declines. Given the historically depressed levels seen last week, is there a case for a more bullish outlook simply based on long-term value?

Crude oil has been on the rise this week, with both Brent and WTI surging higher after a period of declines in the wake of the coronavirus crisis. The reasoning is clear, with Chinese demand likely to fall off a cliff as both businesses and individuals become less mobile in response to the efforts to curb the virus spreading.

After all, Chinese demand made up around 14% of global demand for crude in 2017. Nevertheless, the declines we have seen have taken us into historically depressed levels, with weakness providing potential opportunities for strategic long-term positions.

Crude oil is a natural stabiliser

The beauty of crude is that demand and supply has an element of natural stabilisation as producers react to different prices. The role of the Organization of the Petroleum Exporting Countries (OPEC) certainly does add a more manipulative element to the production outlook, yet the emergence of US production as a force to be reckoned with has helped ensure production is more reactive to prices over recent years.

That means a lower price will price out certain producers, with many halting output or investment which will ultimately lead to lower supply and higher prices. Conversely, higher prices will typically attract greater investment and put producers into maxing out production to capitalise on the high margins.

The recent decline has taken us into the $50.00 mark for WTI, with the price starting to regain ground. What is notable when looking from a historical perspective is that the lower we go, the more of an outlier this decline will appear to be.

For instance, the past 14 years have seen the price start or end the month below the $50.00 mark on just 20% of that time. So less than three years out of 14 have seen the price start or end a month below that level.

The further we fall, the more unusual it is to see prices that low. For instance, just 7% of the monthly candles in the past 14 years saw an open or close below $45.00. Remember, the lower prices go, the more likely we are to see both OPEC and US producers act by trimming back on output.

On the shorter-term time frame, the break through $52.28 provides us with a bullish outlook after a period of downside. That completes a double bottom formation, with the target coming at $55.13.

This recent move also saw the price break through trendline resistance, which ultimately acted as the first tentative sign that momentum could be reversing. Ultimately, the question of whether this is going to be a retracement or bottom remains to be seen, yet further upside does look likely given the huge decline seen throughout January.

Things would look less bullish should we see a break below $51.15. However, if we did see another period of downside to take us back towards the $50.00 or $45.00 region, that would be deemed a great opportunity to look at things from a long-term value perspective and seek out long contacts.

The information on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG Bank S.A. accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer.

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