Crude oil drops again with WTI below $90

Crude oil continues to find strong resistance following the price reversal around mid-June. After last week’s sharp selling, oil prices started this week on the front-foot, but some of those gains are starting to evaporate again. As a result of a weakening demand outlook and no-so-tight supply, both oil contracts have fallen to their lowest levels since February and Russia’s invasion of Ukraine. But the downside could be limited with Europe looking set to start winter short of diesel fuel. China and western governments will also have to replenish their strategic reserves at some point. But still, we could see further short-term weakness in oil prices. WTI could be heading towards low- to mid-$80s.

Demand concerns have been the primary driver behind the weakness in oil prices in the last couple of months or so. High levels of inflation and recessionary signals from Europe to US have weighed on the demand outlook, which is why several oil agencies have revised their demand growth forecasts lower. Indeed, implied US gasoline demand has been weak so far this summer. What’s more, the big oil rally at the start of the year that sent prices to multi-year highs would have also caused some demand destruction, although with prices coming back down again this is not such a big issue anymore.

On top of this, concerns over tight supply have started to ease, as reflected in the narrowing of the backwardation forward curve. The premium for front-month oil contract compared to barrels loading in 6 months’ time has narrowed considerably compared to a month or two ago. Libya’s oil production has improved and this should translate into increased OPEC production, especially as the group continues to ease supply restrictions slowly. There could also be a breakthrough in Iranian nuclear talks after the EU submitted its final draft for a deal, which will now need to be approved by the US and Iran.

The downward momentum has undoubtedly given rise to increased technical selling, which is another factor weighing on prices.

WTI, for example, has broken below several support levels such as the 200-day average at $94.65 and the psychologically-important $90 handle. From here, it looks like US oil is headed below last week’s low at $86.22, possibly dropping to $85.00 before it decides its next move. But potentially, the way has been paved for a drop to the next round figure of $80 per barrel next.

The technical outlook will remain bearish even if we see prices stage a short-term recovery from around current levels, for as long as the bearish trend line holds.

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