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    Crude oil analysis

    26 Oct 2017,

    Crude oil has risen considerably since June. The situation in the market is no longer as clear as it was back then, when the oil was dirt cheap. What direction will the market choose in the short term?

     

    Technical analysis

    Let’s take a look at the December future.

    The price is repeating an interesting pattern. It follows a trendline, only to break it lower, consolidate and then rise again. The key observation is that the trendlines are becoming steeper and magnitude of the swings is decreasing. This means the market is losing momentum and may eventually break down.

     

    Market sentiment

    The sentiment is also rather bearish. Managed money (green) trimmed their bullish bets since the beginning of the year. Nevertheless, their net long positions are still extensive. The swap dealers (red) are heavily short, indicating strong desire of US drillers to hedge their future production at these prices.

     

    Fundamental situation

    However, technicals nor sentiment isn’t the main reason for rising price. This uptrend is fueled by fundamentals. When you look at the supply/demand stats of the US crude oil, you’ll see a significant surge in exports. This is the key catalyst behind the current crude oil strength. There is strong demand for oil in the world, especially China and other emerging markets. Moreover, the OPEC members seems to be willing to carry out the production cuts agreed between the members. This drives up the price of Brent crude, which is a more suitable international benchmark (compared to WTI). In the end, it pays of to ship cheap US crude elsewhere. This relationship is perfectly visualized by the intermaket spread between the Brent and WTI crude oil.

    As you can see, the spread (blue) has surged higher, together with US exports, which lifted the price of WTI (purple). I think this spread is key for future direction of the US crude oil. Untils it breaks donw, the price of WTI will be supported by exports. And as you can notice, it’s just breaking above the resistance at $6. This is even more evident in more distant expirations.

    The divergence between Brent and WTI is also clearly visible when I compare their term structure curves.

    The Brent has already flipped into backwardation. Although the WTI’s curve has steepened a lot, it’s near end is still in contango. I expect this steepening in WTI to continue. It will eventually flip into backwardation in my opinion. This is also the reason why many people will lose money by betting on bear spreads based on various seasonal signals.

     

    Conclusion

    WTI crude oil is overbought in terms of price and sentiment and we may see a short term pullback. However, any pullback (if realized) is likely to be shallow. The intermediate top in crude oil is still ahead of us. $55 is the next target and even $60 is reachable.

    Fundamentals are indisputable. I’ll watch the Brent/WTI spread for clues about the short term direction of crude oil. I won’t be shorting crude until this spread turns down.

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