Fed tapering and oil prices

Oil prices have come a long way since mid-April, but what were the reasons behind that move and do they warrant a $100 barrel?

Oil's initial move in July through the $100 per barrel level for the first time since September 2012 was for the most part driven by a drop in US domestic inventories and concerns about instability in Egypt. Despite the fact that Egypt produces a mere 700,000 barrels per day in a global market of 91 million barrels each day, the country is important as a transit point, hence the risk premium was added to oil prices. The fact that Egypt has control over the Suez Canal was and could continue to be of key concern. Around three million barrels of oil a day are shipped through the canal and Sumed pipeline to the Mediterranean Sea.

Fed QE announcement imminent

Crude prices rose even after comments from US Federal Reserve chairman Ben Bernanke about tapering of the Fed’s asset purchase programme. Can the oil market keep current price levels even after the central bank starts that process?

The rise as a result of Mr Bernanke’s tapering comments can be attributed to the implied confidence that the US will return to pre-crisis growth and therefore create a more sustained demand for oil from the world’s largest economy. Any indication that the Fed are optimistic about US prospects and bolstered by a tapering of bond purchases has something of a short-lived effect, in part due because some of the US economic data has not been all that stellar of late.

The fundamental concern is that any significant Fed tapering will be premature and could deal a blow to global economic prospects and, as a result, to demand for raw materials. This may well put some downside pressure on oil prices as the US dollar will see a boost should the Fed taper by more than $15 billion per month.

Geopolitical influences

Is there any other foreseeable future event that may disrupt the international oil market, such as turbulence in Egypt and Lybia, or a Chinese economy slowdown?

Geopolitical events will always be the cornerstone for oil price moves, and in fact the Syrian crisis is not yet over, with military intervention is still a possibility. Data from China recently suggests that the ‘hard landing’ concerns were overdone. Higher-than-expected industrial production numbers imply that GDP growth for Q3 will be upwards of 7.5%, and this can only be positive for oil demand and should support prices.

Upward resistance at $106

The daily chart on WTI crude oil shows that the topping of oil prices at the $112 per barrel mark could not be bettered, and prices then initiated a significant decline from the $110-level retest. Given that we have seen oil drop through the 23.6% retracement level while maintaining rising support from the bullish channel, the 7 July breakthrough of the $100  mark indicates that we are an important juncture. We could expect that the $106 level will now be resistant to an upward move.  A breach and daily close below the $105 level brings $103.50 into sight.

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