When we look at their price patterns, there is some technical support at current levels for both [crude oil and oil shares] (see horizontal lines above). Sentiment in the short term is getting close to a pessimistic extreme (see Weekly Chart below), but the primary trends (not shown) are still firmly down. Interestingly, our chart above shows the energy sector’s relative performance has clearly broken below its March low, whereas oil prices have not. This observation suggests to us that energy investors are now coming to terms with the idea of lower oil prices for a longer period of time. We think they are right, and the risk for oil prices is that they ultimately break down to a lower low, potentially even re-testing the 2008 lows in the mid-to low-$30s price range. Should that occur, the fundamental case for a longer term bottom would be more compelling as it would likely solicit both a supply and a demand response. Our current fundamental view on oil prices is that a trading range is forming with an upside cap somewhere between $60 and $70, which is where the short-term supply from US producers will increase. As yet, we do not have a strong fundamental view regarding the bottom of the range. In the meantime, we suggest patience.
Here is The Weekly View.
The key variable with any commodity is usually supply. Currently, the world is awash with oil. Traditional producers did not anticipate the technological developments, including fracking, which have produced additional supplies of crude oil. Shocked by their significant loss of revenue, they have responded by increasing production. The Saudi’s, in particular, are waiting, expecting, hoping… that higher-cost production slumps.
This has not happened for two reasons. 1) Too many oil exporting countries are overly dependent on this key commodity. Consequently, they feel they have little choice but to produce as much oil as they can, regardless of the price. 2) When the Saudi’s increased production to hold market share, they underestimated the increasing efficiency of the US fracking industry. Consequently, those initially high-cost unconventional producers are now medium-cost suppliers and confidently predicting lower production costs over the medium term.
Despite a current oversold position and the proximity of the January 2015 lows, the only way Brent crude oil could potentially and temporarily move above the $60 to $70 band would be if the Saudi’s persuaded other OPEC producers to declare ‘victory’ and slash production. However, this would be little more than a Pyrrhic victory, mainly because it would only encourage other countries to develop their reserves of shale oil.Back to top