Where next for crude?

Crude prices have been through a topsy turvy few years, with the 2016 recovery now showing signs of weakness. We look at the relationships between elements that could impact the price of crude and ultimately ascertain an idea of where we could be set to move next.

Oil plant
Source: Bloomberg

With OPEC due to meet in September to discuss crude price stability, the price of both Brent and WTI has regained ground this week as a result of heightened expectations of a production freeze (or cut). Unfortunately, we have seen this before and skepticism will be high given that the Saudi’s have a habit of scuppering any plans to raise prices. We take a look at the state of crude ahead of that September meeting.

Crude prices have taken a turn lower over the past two months, as the rally that has dominated the start of 2016 begins to unwind. Much of this rally has taken place against a story of falling US production, with the continued squeeze from OPEC members finally leading to a decrease in investment. The chart below highlights this shift in production, with June 2015 marking the top for US output. 

US production chart

Interestingly, the crude inventories trend appears to be on the turn, with stocks rising over recent weeks. This goes against seasonal trends, which typically sees inventories fall throughout Q2 and Q3. Could this be a sign that supply is outstripping demand?

US Crude oil inventory chart

This deterioration in crude prices globally have been significantly impacted by this trend in US output (finally following the rig count lower) alongside the recent capitulation of Canadian oil sands production as a result of the wildfires.

Output trends chart

Clearly the price of Crude is a function of both demand and supply globally, coupled with market expectations. The chart below highlights this inverse relationship between supply and price, with Brent bottoming out as world production started to turn lower. 

Output vs Crude prices chart

However, with Saudi Arabia now producing at the fastest rate in history, coupled with the potential for the US production to ramp up once more, could we be set for another fall? The chart below highlights the relationship between crude prices and the US rig count, with rigs (i.e. investment and ultimately output) typically following at a lag of 2-4 months.

Rig count vs Crude prices chart

Interestingly, there seems to be little lag in this relationship, which means that while there is a lag between rising prices and rig count/output, there is little lag between output and prices. With that in mind, the symbiotic relationship between the price of crude and the price of crude. By gaining in value, crude guarantees its own downfall, owing to the agile nature of US operations and price responsiveness.

That said, what would it take for us to see a substantial rise in crude prices? Well, a reduction in output for one, which many will hope can be agreed at the September OPEC meeting. This does not seem likely, given that the initial plan was for Saudi Arabia to push out US production, not lose market share. As such, it seems like a catch-22 situation, where only low prices will drive lower investment and output, subsequently driving the price higher, only for investment to return and prices once more fall. Clearly crude is on the hunt for an equilibrium.

On the weekly Brent crude chart, it is clear that the recent sell-off has highly bearish connotations. The inability to break through $54.78 means that we remain within a downtrend over the long-term, with lower highs remaining in play for now. Interestingly, we do have a relatively oversold stochastic and price currently moving higher from just below the Q3 2-2015 low of $42.50. However, until we break through $54.30, the downtrend remains intact.

Brent weekly chart

Meanwhile, the break below $43.52 means that this bearish outlook also corresponds on the shorter timeframe, with price having created a new lower low. Yes we have begun to make up ground over the past week. However, unless we break back above $44.82, this bounce is likely to return lower once more before long. The 76.4% retracement at $47.10 is of particular interest. 

Brent daily chart

Ultimately, this is a story of a market which will have wide swings in either direction as supply adjusts to the changing market price. Currently we are seeing rigs rise, which is likely to lead to an increase in US output. Meanwhile, the Canadian output is likely to come back on grid soon and the OPEC meeting will likely yield precious little, thus consigning the current bounce to the heap once more.

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