Oil Prices Approach a Pivotal Support Level

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February 3, 2020 11:35am NYSE:USO

NYSE:USO | News, Ratings, and Charts

  • A higher low, but an ugly technical pattern
  • OPEC meeting in March
  • The wrong time to get overly bearish

On January 8, as tensions between the US and Iran rose to a boiling point in the Middle East, the price of crude oil rose to its highest level since April 2019 and came within 95 cents of that peak. The nearby NYMEX futures contract rose to a high of $65.65 per barrel. In mid-September 2019, the price rose to a lower high of $63.38 per barrel as a drone attack with Iranian fingerprints temporarily took out half of Saudi Arabia’s daily production. By the end of September, the Saudis restored their output, which sent the price to a low of just under $51 per barrel in early October.

NYMEX crude oil futures then spent over three months taking the stairs to the upside. OPEC production cuts and the de-escalation of the trade war between the US and China were supportive of the price of the energy commodity. On January 8, as Iranian missiles rained down on Iraq airbases that house US troops, the price of crude oil spiked higher. In the aftermath of the January 8 attack, the situation in the Middle East calmed, and the price of oil moved lower. The outbreak of Coronavirus in China caused even more selling in the oil market as economic weakness on the back of the virus is likely to reduce the demand for crude oil in China. At the end of last week, crude oil was trading at just above the bottom end of its trading range over the past year. The United States Oil Fund (USO) is the ETF product that moves higher and lower with the price of NYMEX futures on a short-term basis.

A higher low, but an ugly technical pattern

Since January 8, the price action in the crude oil futures market has been bearish. The price of nearby March NYMEX futures settled at $51.56 per barrel on Friday, January 31, after trading to a low of $50.97. Crude oil may have avoided making a new low below technical support at the August $50.52 low, but the price action in January could mean it is just a matter of days until the price falls below that level.

(Source: CQG)

The monthly chart shows that the energy commodity put in a bearish reversal on the long-term chart in January. The price rose to a higher level than the previous month and settled below the December 2019 low. The last time crude oil put in a bearish reversal on the monthly chart was in October 2018, when it rose to $76.90 and closed the month at $64.86 per barrel. By late December 2018, the price had declined to a low of $42.36 per barrel. If history repeats, the price action in February could get ugly on the downside.

Price momentum and relative strength indicators have turned lower in the lower region of neutral territory. From a technical perspective, the crude oil futures market has room to decline over the coming week. Open interest has been gently rising, which is a technical validation of the bearish price trend. Monthly volatility has been climbing since November 2019 as the energy commodity took the stairs higher and is currently riding an elevator to the downside. The price has posted losses over the past four consecutive weeks.

OPEC meeting in March

At the last OPEC meeting at the end of 2019, the oil ministers agreed to further cut production from 1.2 to 1.7 million barrels per day. Saudi Arabia threw in another 400,000 barrels for good measure, bringing the total amount of the output decline to 2.1 million. In early March, the international oil cartel will review the impact of its production cut, and if the price remains around the current level or moves lower, they may have to make an even deeper cut. OPEC ministers believe that the preferable range for the energy commodity is between $60 and $70 per barrel on the nearby Brent futures contract.

(Source: Barchart)

March Brent futures rolled to April at the end of last week. With the Brent futures at $56.62 per barrel, the price is below its desired range.

Another cut from the oil cartel could provide some support for the price of the energy commodity. However, US output is at 13 million barrels per day according to the EIA, and the review of OPEC policy will not occur until the first week of March. February tends to be a bearish month in the crude oil futures arena. In 2016, the price fell to a low of $26.05 per barrel during the second month of the year.

At the same time, Iran remains a clear and present danger to crude oil production, refining, and logistical routes in the Middle East, the home to over half the world’s oil reserves. Around 20% of the world’s supplies travel through the Straits of Hormuz each day. Any provocative acts by the Iranians could cause a reversal in the current trend in the crude oil futures markets. The mid-September and early January rallies stand as examples of the upside potential for prices. Peace in the Middle East is unlikely to break out any time soon.

The wrong time to get overly bearish

Markets tend to look their best on rallies and worst when the price is falling. Crude oil has been a falling knife, shredding any market participant that dips a toe into the futures arena on the long side since January 8. The price looks set to challenge the $50 level, and many analysts are likely to begin calling for a test of the 2018 low of $42.36 per barrel. However, the risk of a price spike on the upside on the back of Iran remains a threat to the bearish trend.

The first test for crude oil comes this week. The $50 per barrel level on nearby NYMEX futures is a critical level of psychological support for the energy commodity. Fundamental and technical factors continue to point to lower prices and a continuation of the bearish trend. However, any surprise is still likely to come on the upside over the coming weeks and months.

The United States Oil Fund LP (USO) was trading at $10.66 per share on Monday morning, down $0.18 (-1.66%). Year-to-date, USO has declined -11.24%, versus a 22.41% rise in the benchmark S&P 500 index during the same period.

USO currently has an ETF Daily News SMART Grade of A (Strong Buy), and is ranked #1 of 109 ETFs in the Commodity ETFs category.

About the Author: Andrew Hecht

andrew-hechtAndrew Hecht is a sought-after commodity and futures trader, an options expert and analyst. He is a top ranked author on Seeking Alpha in various categories. Andy spent nearly 35 years on Wall Street, including two decades on the trading desk of Phillip Brothers, which became Salomon Brothers and ultimately part of Citigroup. Over the past decades, he has researched, structured and executed some of the largest trades ever made, involving massive quantities of precious metals and bulk commodities. Aside from contributing to a variety of sites, Andy is the Editor-in-Chief at Option Hotline.

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