- OPEC+ sticks to January output hike, but demand collapse may be imminent with the emergence of the omicron variant.
- Powell announces an increase in asset purchase tapering, sending inflation breakevens lower.
- Inventory releases suggest supply is dwindling on the back of volatile market conditions and a return to normalcy might provide a demand shock.
- Technical indicators suggest a larger drawn-out decline is in order based on Elliott Wave analysis, price level establishments, and fundamental factors.
The sharp decline in West Texas Intermediate Crude Oil prices on the back of the omicron coronavirus variant outbreak has left many key market participants and facilitators reeling from the shock. Compounding the price action collapse were statements made by OPEC+ on planned future production hikes and Jerome Powell on the state of asset purchase programs. However, corrective moves in the sharp decline were fortunately provided by data releases by the Energy Information Administration (EIA) and the American Petroleum Institute (API). An interesting point of observation, as will be elucidated later, is how the price action stuck to key price levels despite the severe implications and the instantaneous severity of the price decline triggers. As we will see earlier, further downside for crude oil may be ahead based on technical information derived from chart analysis.
Overview of Fundamentals
The conclusion of the OPEC+ meeting held this week in a highly volatile oil market environment was crucial to establishing key factors affecting the price of crude oil. An announcement on the plans to continue production increases into next month with production quotas being announced sent West Texas Intermediate crude up 1.71% on the day against general expectations. Previously, however, uncertainty lingered over the group’s decision to stick to planned production increases of 400K bbls/day per month agreed to under a summer agreement after Rystad Energy forecasted a demand loss of 3M bbls/day in 1Q22.
Furthermore, the correlation between 10-year yield breakevens and crude oil was further elucidated today when Chairman Jerome Powell stated in a Congressional testimony that “It is appropriate to consider a faster pace of tapering.” The 30-year treasury yield slid to 1.775% and currently is lower at 1.764%, the lowest since the beginning of the year. As of Dec. 1, the 10-year breakeven inflation rate stands lower at 2.44%, which has further pushed WTI downward in a clear demonstration of the good correlation between WTI and 10-year breakeven yield, as shown in Figure 1.
Figure 1: 10-Year Breakeven Inflation Rate and West Texas Intermediate Crude Oil Prices (Source: Federal Reserve Economic Data)
The Energy Information Administration and the American Petroleum Institute release weekly petroleum inventory reports detailing crude oil inventory levels for the previous week. API reports are generally considered soft forecasts for the EIA Reports, which are public, as the API releases their inventory report 18 hours before the EIA releases their report. The recent API inventory report states a 747,000 bbl drawdown in crude oil inventory levels for the week of Nov. 24, which was a drop from the previous week’s level at a 2.307 MM bbl build and undercut a forecast of a 1.667 MM bbls drawdown. Shown in Figure 2 is a chart of historical crude oil inventory levels as published by the EIA with SPR inventory levels provided separately. For the week of Nov. 24, the EIA reported a 900,000 bbl drawdown in inventory levels, bringing the total inventory level to about 6% below the five-year inventory average for this time of the year.
Figure 2: Weekly Stocks of Crude Oil Reserves and SPR
The OPEC+ meeting together with announcements on tapering asset purchases by Jerome Powell provided significant downward pressure on prices from a fundamental standpoint after the omicron variant announcement. Consequently, the positive influence of the inventory drawdowns was significantly and proportionally muted. Nonetheless, short corrections in the price collapse did occur partly as a result of inventory drawdowns. Interestingly, quickly timing the news breaking on the wires with the price action maneuvers shows that the severity of each announcement was either kept in check or exaggerated by the price action following trends and market momentum in proportionate fashion.
Figure 3: YTD Price Action of West Texas Intermediate Crude Oil with Technical Trends and Indicators
The price action had recently entered a descending triangle pattern as confirmed by a previous article and depicted as a red triangle in Figure 3. However, given the fundamental backdrop of the week, the price action fulfilled the descending triangle early, collapsed through the pattern support, and began testing key price levels and descending trends in accordance with post-omicron-declaration sentiment. At the close on Friday, West Texas Intermediate had tested the $67.30/bbl level before falling through the $64.48/bbl as the midpoint for temporary support before attempting to unsuccessfully test the $61.66/bbl level. The day after the omicron variant emergence announcement saw WTI crude retrace much of its decline over its high-to-low range with a brief test of the $72.94/bbl level as resistance. The price action maneuvers occurring within the context of these key equidistant price levels, shown in turquoise in Figure 4, is indicative of the relevance in evaluating WTI price action within the context of these price levels.
The methodology used for the development of these price levels contains a combination of qualitative and quantitative methods. Firstly, a key price level used for support over at least three months was visually determined, which initially was established at $61.66/bbl. Secondly, a key resistance level that was later converted to a support was also determined visually. Thirdly, the distance between the support and resistance price levels established was calculated and applied to construct a third price level above the established resistance line. Fourthly, if there were sufficient data points to construct a price level appropriately, then the distance between the lines constructed in the first and second steps was established as the concrete distance between lines and more lines were constructed; conversely, if visual analysis determined the price level did not adequately represent a support or resistance level for the price action, the first three steps were conducted iteratively until an optimum distance was obtained.
Elliott Wave analysis shows that the beginning of the parabolic descent in WTI crude on 26 Oct. began at the termination of two key bullish trends – a long-term one shown below in Figure 4 and a short-term wave shown in Figure 3. The long-term Elliott Wave trend was plotted with an initiation point occurring after the Apr. 2020 lows into negative territory. The corrective 1-2 and 3-4 waves on the long-term pattern were taken to be occurring during the consolidations in the Fall of 2020 and in the Summer of 2021 respectively. Given the descending trendlines, key price level establishments, and the termination of key Elliott Wave price movements, it is very likely that WTI crude has entered a long-term corrective phase which could see prices pushed down to new short-term lows in the next year given the lingering uncertainty surrounding the economic fallout from the pandemic.
Figure 4: Price Action of West Texas Intermediate Crude Oil with Technical Trends and Indicators from 2020
It remains to be seen how the consequences of the SPR release particularly would unfold over time given the backdrop of the OPEC+ decision and inventory levels. The historically low inventory levels currently recorded would prove to be a catalyst for future fundamental supply challenges were this to continue. New discoveries may be announced in the future to stave off further long-term exponential price appreciation, but in the short term the pandemic still poses a serious threat to demand. Elimination of lockdown protocols and a complete reopening of the global economy in the current fundamental backdrop would leave traders and refiners scrambling to book more supply. Consequently, technical price levels would be in play in proportion to the severity of the fundamentals. For now, the price action may have entered a sharp correction which could last well into 2022.
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