Crude oil shorts squeezed hard

The following is the updated version of the oil report I wrote earlier this week:

Crude oil surged higher on Thursday and after a brief pause extended its gains on Friday. Since hitting a low of $42.20 on Monday, Brent has risen by $7.30 to a high so for of just over $49.50. In percentage terms, it has gained a good 17%. WTI has likewise gained $7.30 from its low but because it has risen from a lower base, it has outperformed on a percentage basis – up just under 20% over the same period. From a fundamental point of view, not a lot has changed although most of the bearish news is surely now priced in. In other words, the sellers have had no reason to hold on or add to their existing positions, even if the dollar has managed to bounce back strongly. Put another way, it looks like oil prices have merely staged a short squeeze rally.  For price gains to be sustained, the bulls will now want to see signs that the global supply glut is going to reduce. At the moment however, there are no such signs although the sharp 5.5 million barrel drawdown in US crude stocks last week was a bit of a surprise. Though the weekly change in crude stockpile levels since the start of the summer has generally been negative, the magnitude of the declines has been very modest. Indeed, the most profound weekly decrease was just 6.8 million barrels in early June. Given that we are now in the twilight of the summer driving season, gasoline demand is set to fall. The usual refinery maintenance works will further reduce demand. It is thus unlikely we will see further sharp declines in crude stockpiles levels – unless many shale producers go out of business all of a sudden. But this may only happen if oil prices remain low for a long period of time.  Thus, even if oil manages to extend its rally from these depressed levels, it is unlikely that we will see significantly higher prices for the foreseeable future.

But in the short term, more gains could be on the way if prices manage to break some more key technical levels that are now being tested. Momentum buying alone could fuel another sharp rally.  As the daily chart of Brent shows, the London-based oil contract is hovering just below resistance at $50, having already broken out of a bearish channel and horizontal resistance at $48.00 on Friday. If the sellers fail to defend this $50 hurdle then we may see the short-squeeze rally extend towards the next resistance and 38.2% Fibonacci retracement level at $52.50 or even $55 before it decides on its next move. The old resistance levels such as $48.00 and $45.00 could now turn into support should oil prices head lower. WTI meanwhile has broken its bearish trend line around $40.30 and taken out several horizontal resistances including $42.00 and $43.20 – levels that may now turn into support upon re-test. If the bulls reclaim the $45 handle then a move up to the 38.2% Fibonacci level at $47.20 or even the psychologically-important level of $50.00 will not surprise us.

Although from a fundamental point of view we think that this latest bounce in oil will not last long, we cannot ignore the fact that both contracts have created what look like false breakout reversal patterns on the daily chart i.e. the bears have failed to hold their ground below the earlier 2015 lows that were breached recently. In other words, major bottoms may have been established now – at least that’s what the charts are telling us.