Oil futures have spent much of the past year in a bear phase. Selling pressure with a series of lower highs and lower lows has driven the price to lose as much as -49% of its value since June 2022. However, something has changed in recent weeks. Fundamentals on both supply and demand sides have aligned to drive a recovery. The rally is now reaching a crucial crossroads as the oil-positive news continues.
- Tightening supplies remains supportive for oil
- The prospect of a soft landing in the US and Chinese stimulus paints a more positive demand picture
- The reaction to crucial technical resistance will be key for sustaining the recovery momentum
Restrictive supply is oil positive
The OPEC+ countries have been restricting oil supplies since the fallout of the pandemic. However, these restrictions have cranked up in recent weeks. OPEC+ members once more pledging to extend their cuts in June. However, in addition to this, Saudi Arabia has pledged to cut its output by 1 million barrels in August whilst Russia has also said that it would cut by 500,000 barrels too this month.
According to Reuters, OPEC pumped 27.34m barrels per day (bpd) in July, down from 28.18m bpd in June. The reading for July was the lowest that Reuters has recorded since September 2021. A drop of 860,000 bpd by Saudi Arabia was the standout, but the record low production is being exacerbated by an outage in Nigeria, protests in Libya and capacity issues in Angola.
The news of the production cuts in Saudi Arabia and Russia started the ball rolling in the rally on oil futures in July that has continued for several weeks. It is expected that Saudi will continue the voluntary production cut of 1 million bpd into September.
A “soft landing for the US, near the Fed peak and Chinese stimulus help demand
These supportive fundamentals on the supply side are now also increasingly being met by supportive demand fundamentals too. News concerning the world’s two largest economies is driving the price higher.
The signs are increasingly that the US economy may after all be in for a “soft landing”. Inflation is falling whilst the US labour market has been holding up well. Fed staff members no longer forecast the US economy falling into recession. As a crucial aspect of this, the Federal Reserve is now at or very close to its peak rate with the Fed Funds at 5.50%. This is allowing a more constructive view of US demand to form.
Data yesterday from the American Petroleum Institute (API) showed oil inventories falling by 15.4m barrels last week. Analysts had expected a decline of 1.37m barrels. This is a huge reduction and if met by similar reductions in the US Government data today, would be the largest decline since 1982. According to the API, gasoline inventories and distillate stocks also fell decisively last week.
The big reduction in inventories paints a picture of growing demand in the US. However, it also comes as the talk of Chinese stimulus is hot in the minds of traders. The Chinese authorities are talking about measures to support consumption, but also to help support the property and local debt markets. Nothing has been formally announced yet, but the wheels are turning and stimulus is coming. At least this is what markets such as oil futures are factoring in.
Oil futures have rallied to a crucial crossroads
I have been closely tracking the move higher in NYMEX Oil futures in recent weeks as the rally has developed well. The question is how far can the momentum in the rally take the oil price. Technically the recovery is looking very strong still, however, a significant barrier of resistance lies ahead. Throughout 2023 there has been a huge ceiling at $82.65/$83.53 on NYMEX Oil futures that has restricted the upside. This is a resistance that needs to be decisively breached to continue the recovery.
This is a positive outlook on the technical analysis. The market has been in an uptrend over the past five weeks. The price is now trading decisively above the 200-day moving average for the first time in about 12 months. Furthermore, it is a move that is being confirmed with strong momentum on the Relative Strength Index.
However, this resistance marks a key crossroads. Also, look at the RSI, now hitting 70. The last time a decisive rebound took hold (in April), the RSI reversed sharply from 70. This is the real test now. A rally that has strong foundations can survive with the RSI pushing around 70. It can be a reflection of the strength of the trend. Whereas, traders will see an extreme move rally that is built on shaky ground as a chance to take profits.
Given the likely continued supply restrictions, the more encouraging economic data from the US and the prospect of Chinese stimulus, this looks to be a strongly formed rally that can keep going. Above $83.53 the next important resistance is not until $93.75. I will though be keeping an eye on the reaction to the formal announcement of any Chinese stimulus. If it underwhelms, it will be a key test for the rally in oil futures.
