Crude Oil Steady- The Odds Still Favor the Upside

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August 18, 2020 9:36am NYSE:USO

NYSE:USO | News, Ratings, and Charts

  • Production cuts are working
  • US output should continue to decline
  • The trend is your friend, and the dollar reversed- Levels to watch on the upside

The price of crude oil continued to sit near the recent high last week. At the $42 per barrel level on Friday, August 14, the energy commodity was close to the recent high of $43.52 on the September futures contract. Crude oil has been making higher lows and higher highs since hitting the lowest level in history on April 20 when the nearby futures contract fell into negative territory for the first time.

The September contract hit a low of $21.99 per barrel because of the wide contango, or premium for deferred delivery. A wide contango signifies an oversupplied condition in a commodity market. The global pandemic that caused businesses to shut down worldwide caused the demand for the energy commodity to evaporate. Storage facilities reached capacity levels, causing the contango to grow to an unprecedented level in April.

Since then, global production has declined, balancing the fundamental equation for the oil market. As of the end of last week, the path of least resistance for the price of crude oil remained higher. The United States Crude Oil Fund (USO) tracks the price of oil higher and lower.

Production cuts are working

One of the reasons why the price of crude oil fell to a negative price on the nearby NYMEX crude oil futures contract in late April was OPEC and Russia’s decision to abandon production quotas at the beginning of the global pandemic. The cartel and Russians quickly realized that the ill-advised move pushed the price of the energy commodity off a bearish cliff.

After watching the price cascade lower, OPEC, Russia, and other world producers agreed to slash daily output by nearly ten million barrels. The unprecedented quotas lasted until the end of July. As the price of crude oil recovered to the $40 per barrel level, the group announced a tapering of the production cuts to 7.7 million barrels per day in August.

The production reduction went a long way towards balancing the supply and demand fundamentals for the crude oil market that sent the price of WTI and Brent futures back to over the $40 per barrel level. The price has been consolidating at that level since June.

US output should continue to decline

The United States became the world’s leading crude oil-producing country over the past years. Technological advances in extracting the energy commodity from the crust of the earth and regulatory reforms under the Trump administration supported output. US daily production rose to a record 13.1 million barrels per day in March 2020. However, the evaporation of demand that caused the price of the energy commodity to fall to unprecedented prices resulted in far lower production.

According to the EIA, daily output in the US has declined by over 18% to ten mbpd as of August 7. At the same time, inventories of crude oil in the US have been falling over the past three weeks, according to the Energy Information Administration and the American Petroleum Institute. The two agencies reported a total decline of around twenty million barrels of crude oil stocks since the week ending on July 24.

Baker Hughes has been reporting the steady fall in the number of oil rigs operating across the United States. As of the end of last week, the number of rigs in operation stood at 172 compared to 770 last year.

The bottom line is that the trend in oil production in the US is lower, and that should continue to support the price of the energy commodity.

The trend is your friend, and the dollar reversed- Levels to watch on the upside

The US dollar is the benchmark pricing mechanism for the international crude oil market. A strong dollar tends to weigh on the price of oil, while a falling dollar is a bullish factor.

Source: CQG

The weekly chart shows that the dollar index fell from the highest level since 2002 in March 2020 at 103.96 to a low of 92.475. At 93.110, at the end of last week, the dollar index is close to the low, which is bullish for the price of crude oil and other commodities.  

Source: CQG

The daily chart of NYMEX September crude oil futures illustrates the bullish trend since the late April low. Price momentum and relative strength indicators were above neutral territory as crude oil has been crawling higher. The latest low came on August 5 at $43.52 per barrel. At over the $42.20 level on August 14, the energy commodity was sitting just below the short-term peak.

Lower global production, declining US inventories, a weaker dollar, and bullish technical trend all point to a continuation of the slow and steady rally in the crude oil market.

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The U.S. Oil Fund LP (USO) fell $0.35 (-1.14%) in premarket trading Tuesday. Year-to-date, USO has declined -70.27%, versus a 6.27% rise in the benchmark S&P 500 index during the same period.

USO currently has an ETF Daily News SMART Grade of D (Sell), and is ranked #73 of 111 ETFs in the Commodity ETFs category.

About the Author: Andrew Hecht

andrew-hechtAndy spent nearly 35 years on Wall Street and is a sought-after commodity and futures trader, an options expert and analyst. In addition to working with StockNews, he is a top ranked author on Seeking Alpha. Learn more about Andy’s background, along with links to his most recent articles. More…

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