Crude oil tests the $30 level as bears wade in
After two successful bearish calls on oil I am now looking to the upside for the next substantial move.
Crude oil has been hitting the headlines across the world after a weak finish to 2015 led to further lows, with the price dipping below the $30 level on Tuesday.
As the price has continued to tumble, a host of investment banks have come out to forecast oil at $20 or even $10 in the near future. For me, this is the icing on the cake for a technical setup that is warning of a short-squeeze that could see some respite in oil for the next couple of months and provide some speculative opportunities in the battered sector.
Technicals are setting up for a rally
In an article I wrote one year ago (Crude Oil Is Setting The Trap) I warned of a technical setup in the futures markets that was still heavily skewed to the upside. An unprecedented build in speculative positions as oil traded over $100 was a key factor in the 70% drop that we have seen since.
The resulting drop in oil over the last 12 months has helped to shake the tree and remove a large portion of those long positions, while the bearish price action has also turned many investors away from the commodity. These two factors are a necessity for a short-squeeze that catches the majority of investors off guard.
(Source: Commitment of traders/Kevin George)
The most recent Commitment of Traders report also shows a continued build in commercial longs as the price continues lower. Historically, commercials tend to be on the right side of price reversals.
The first level we need to watch in oil is $34.25. This would be the target if oil holds above the $30 level and would open up further gains to $37.80 and $42. An ability to get above here would see $50 a barrel possible and this seems a reasonable target with the current tensions in the Middle East, where any disruption to supply, especially in the Strait of Hormuz would put paid to the current focus on U.S. inventories and Chinese demand.
Recent analysis has also pointed to the lack of storage space amidst the ongoing oil glut, which would force refiners to slow down, creating a reduction in demand in the near-term.
Medium-term still troubling for the sector
As I already stated, this rally in oil would offer speculative opportunities in oil and energy stocks, although the medium term outlook for the sector is still uncertain.
Saudi attempts to harm the U.S. shale sector has not seen the expected results with many companies able to cut costs and lower their break-even level on projects but the drop the resulting drop in earnings has squeezed the balance sheets of shale companies and majors alike. This would be a welcome time for a sustained rally if we are to see a Houdini-esque escape for some of the embattled companies.
Looking ahead, oil firms are likely to stay trapped in a climate of fear and protection, and the heavy cuts to CAPEX will be a drag on the sector even in the event of higher prices. This reduces my desire to look for long-term investments in oil companies.
The ongoing supply glut in oil is heavily subscribed to and the price has gone further to addressing this imbalance with further losses through the $40s and $30s. As the market now probes beneath the $30 level, the front page headlines warning of further gloom has the feel of a bottom in price. The extreme losses have also helped to shake out more of the speculative longs that distorted the futures market and has scared many investors and creditors away from the sector. This is the perfect climate for a swift short-covering rally, which could see U.S. crude oil trading at $50 by mid-March.
Disclosure: I am/we are long CRUDE OIL FUTURES.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.