Commodities | Aug 14 2014
By Kathleen Brooks, Research Director UK EMEA, FOREX.com
Considering the amount of geopolitical risk going on, one may wonder why Brent crude oil has dipped to its lowest level of the year so far. Russia/ Ukraine tensions remain on-going, Iraq is in the throes of civil war and Libya is also descending into chaos once again. Since Europe relies on Russia and the Middle East for most of its energy needs, it is puzzling why the market seems so sanguine. Rather than buy oil, open interest in the Nymex Brent crude oil contract, which measures speculative interest in crude, has plunged by 125% since the start of this year.
So why is oil not rallying in response to these external risks? Supply, supply, supply. The International Energy Agency (IEA) in its monthly report released earlier on Tuesday, reduced estimates for global oil consumption by 180,000 barrels per day for 2014, and by 90,000 barrels per day for 2015. However, supply remains plentiful, with excess barrels coming from North America and Opec, where daily production topped 30.44 million barrels per day, a 5-month high, as Saudi and Libya both ramped up production.
Libya may be in the throes of another civil conflict, but its oil supply continues to come back on line, and production could reach 450,000 barrels per day in the coming months. However, even with the threat of another conflict in the country, the IEA reported that Libya is struggling to sell its oil.
The response to this supply glut has been a fall in crude inventories in the US, a top consumer of oil and oil products, but not even that has managed to stem the tide of capital flowing out of the oil markets.
How long will the decline last?
This is notoriously hard to predict, but we will give it a go. The problem for oil right now is that the supply glut is not likely to go away any time soon. Unless Opec drastically cuts production, or the US stops pumping oil, two things we doubt are going to happen, then the oil price could struggle to make further gains.
From a geopolitical perspective, considering the oil price has shrugged off the most recent external risks, then the situation in Russia and the Middle East would have to take a dramatic turn for the worst to reverse this bearish trend.
Oil and other commodities:
The recent strength in the dollar is not helping the outlook for crude, since a stronger dollar can put downward pressure on commodities that are priced in the greenback. However, commodities are not moving together. As you can see in the chart below, gold and the oil price had been moving together for most of the last 12 months, but since the start of this month the two commodities have been moving in opposite directions. While we concede that there are many factors that drive the oil price, the breakdown in this correlation is worth watching. If gold can continue to push higher then oil may follow suit, however, in the short term, if this relationship is to persist then gold may need to move back in line with the weaker oil price.
The technical view:
After falling more than 4% since the start of the month, Brent is starting to look oversold, and the daily RSI is below 30, which suggests that it is stretched to the downside. Thus, it could be due a pullback in the short term. We think any pullback could be limited, and a recovery could be capped at $105.50, the high from Monday.
With momentum firmly to the downside, the path of least resistance is for a further decline. Earlier on Tuesday this commodity fell below the top of its monthly Ichimoku cloud chart at $103.95, which is a medium-term bearish development. A daily close below this level could see further declines back to:
- $102.98 – the low from 8th November 2013.
- $100.19 – the 61.8% retracement of the June 2012 – Feb 2013 advance.
Conclusion:
The oil price is looking downbeat and not even geopolitical risks can trigger a recovery. The technical picture remains bleak, and any pullback in the short-term could be limited.
We think it is worth watching the price of oil closely, especially if you trade stocks. Oil prices could be trying to tell us something about the global economic outlook. As geopolitical risk mounts at the same time as some major central banks contemplate normalising monetary policy, the global growth forecast may be too rosy. If this is the case, then the recent pullback in stocks could be the sign of things to come.
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