Comment: Oil price decline is not over yet

Date: Tuesday 07 Oct 2014

Comment: Oil price decline is not over yet

After a fairly uneventful first half of the year, oil has broken lower, writes IG's chief market strategist Brenda Kelly, and has the potential to break through current price support.
For the most part, oil traders need to be nimble and conduct trades with fairly wide stops.

As markets go, oil can be fairly volatile with broad daily ranges, so certainly not an area for rookie traders to delve. The average range recently has been around 100-200 basis points.

Having spent the first six months of the year in a fairly predictable range with $112 per barrel (bbl) at the peak and $105/bbl at the base, oil is now trading at a two-year low, well below the psychological $100 level.

As is often the case with supposedly bullish trend break outs that quickly reverse, the move to just shy of $116/bbl back in late June of this year was the final hurrah for oil bulls.

Bear in mind, that up until this point, the US dollar index was stuck in a range, unable to break higher and little or no volatility in FX crosses to provide any catalyst.

Thus the fact that the dollar has been on a bull run since the end of June does tell a story about why oil prices and indeed the majority of commodities have declined.

A strengthening of the inverse relationship between the price of Brent crude oil, which is traded in US dollars, and the dollar exchange rate has been evident since 2002, with the gradually rising price of oil having been accompanied by depreciation of the dollar and vice versa.

There are other factors at play too. The basic laws of supply and demand should also be considered.

Crude prices are under pressure owing to the weaker than expected anticipated growth in the likes of China and the euro zone. Oil supplies remain strong which is leading to growing inventories.

The main source of supply growth comes from the USA. The shale boom has meant that the US now produces about 8.5m barrels per day and could now rival the likes of Russia and Saudi Arabia in oil output.

This surge in production has allowed the US to ignore any potential issues in supply as a result of the confrontation with Russia over Ukraine as well as the instability seen in Syria and Iraq.

Prices are also in contango and traders are taking advantage of that. When prices for future delivery exceed spot prices, it clearly makes sense to keep oil in storage until it can be sold forward.

Normally, one could expect to see some degree of intervention from the OPEC countries but it seems that any moves to cut production in a bid to stem the falling price seem for now to be elusive.

A scheduled meeting in November may see some action but it appears clear that Saudi Arabia are not willing to balance the market alone, Iran and Iraq are also expected to share the downsides that come with production cutbacks.

The fact that Saudi actually cut its prices in an effort to keep market share tells you than intervention seems unlikely.

Weak manufacturing and industrial output has also been a theme lately - as long as that continues to be an issue, the demand will not be there.

So what next? Has the dollar already started to run out of steam or will the cold imminent winter provide a floor.

For now, the oil price seems to be finding a support around $91 - but with my predilection for trend following, betting against the dollar has not been a profitable trade of late and a long oil position is essentially just that.

I see oil breaching $91; the potential price floor is closer to $88.


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