The Quick and Dirty on Crude Oil

Crude oil has surprised many this year.

When it was trading at $33.75 per barrel on 1 March, I wrote in Money Morning: ‘You have to wonder, is a breakout to higher levels on the cards?’ At the time, the majority of investment banks were claiming it would drop to US$20 per barrel.

As always, these trend followers were dead wrong.

When I warned that it isn’t as strong as it appears on 6 June in Money Morning, crude had surged to about US$50 per barrel. At that stage, Goldman Sachs — and its investment banking buddies — had jumped on the bullish bandwagon. Goldman forecasted that crude would hit $60 per barrel by year’s end.

The forecast has worked out well…

Brent crude, the international benchmark, has pulled back to US$46.63 per barrel today. While I expect the good days are over, it’s still trading 66% higher than the low of US$27.83 per barrel on 20 January. West Texas Intermediate (WTI), also known as US crude, is trading at US$45.23 per barrel. It’s up 73.6% from the low of US$26.05 per barrel on 2 February.

If I’m correct, crude has peaked, and should make a new low in the months ahead.

I’ll explain…

Investment banks forecasts…here we go again

Let’s start with some mainstream analysis. CNBC reported on crude last Friday:

“Inventories are high and we are in the withdrawal season. Things could get worse when we enter late August and September when inventories usually build,” said Hamza Khan, head of commodities strategy at Netherlands-based ING Bank, which expects Brent to average $40 in the third and fourth quarters.

BNP Paribas analysts [believe that]“very little implied global stock change will occur from Q3 2016 until the end of 2017 in oil. As such, the inventory overhang built from the start of 2014 will remain largely in place, and thus continues to represent an impediment to any price rally.”

Some analysts are more optimistic.

Bank of America Merrill Lynch’s energy research team maintained its outlook for 2017 oil demand, saying it will grow by 1.2 million barrels per day to bring supply into a deficit. Brent will hit $55 a barrel by end-2016, it forecast.

While most of that information is quite useful, the broker forecasts — and even those in the right direction (i.e. on the lower side) — are still way too high.

See, brokers are paid to be bullish. If they aren’t, their clients (major blue chips) will do their business (acquisitions, capital raisings and IPOs) with someone else. For this reason, if you read broker research, take their forecasts with a grain of salt.

Now, I’m not saying that I get everything right. No one does. But I’ll pit my common sense forecasts against the major investment banks, commercial banks and brokers any day.

When crude was trading at US$78 per barrel in November 2014, the banks were bullish. I said it would fall to US$58 per barrel. At the same time Mark Pervan, Head of ANZ Research, told the ABC, ‘I think oil prices around these levels are about, I suppose, close to the bottom.

In August 2015, Reuters wrote that ‘Citi lowered its base case Brent price forecasts to $54 per barrel for 2015 and $53 in 2016 from $58 and $63, respectively. Citi said it assigns a probability of 55 percent to its base case forecasts.’ It was a convenient and ‘safe’ forecast. At the time, crude had rallied to around US$60 per barrel. I said it would crash to US$30 per barrel by the end of the year. My forecast was off…by a couple of weeks.

In my view, contrary to mainstream opinion, crude may still make a new low in the months ahead.

Technical analysis

Earlier in the year, I said that US shale companies should start drilling and producing more wells when the oil price hits US$50 per barrel. It appears this warning is on track, which is why I’m not bullish on crude. Investing.com reported yesterday,

Oilfield services provider Baker Hughes said late Friday that the number of rigs drilling for oil in the U.S. increased by six last week to 357, the third straight weekly gain and the sixth increase in seven weeks.

The renewed gain in U.S. drilling activity fuelled speculation that domestic production could be on the verge of rebounding in the weeks ahead, underlining worries over a supply glut.

According to the U.S. Energy Information Administration, crude oil inventories declined by a less-than-expected 2.5 million barrels last week to 521.8 million, which the EIA considered to be “historically high levels for this time of year”.’

With more wells being drilled and produced, it seems like the supply story is set to get worse in the short term. At the same time, crude oil demand is still weakening. The world’s heading into a deeper deflationary phase, which will get worse before it gets better.

Clueless politicians are to blame. Other than raising taxes and increasing regulation, they’re out of ideas. It’s clear that businesses have no incentive to spend and expand. Consumers will just hoard capital. So, it’s no surprise crude oil demand should only get worse.

Yet, despite all the fundamental analysis, the price will do the talking at the end of the day. With this in mind, check out the monthly chart on Brent crude below.


Source: Resource Speculator; Tradingview.com

[Click to enlarge]

The chart shows that crude peaked at US$52.83 per barrel in June.

I find it interesting that, just before crude fell off a cliff in November 2014, this year’s June high lines up with the green major resistance trend line. The major resistance dates back to the 2014 high of US$115.68 per barrel.

Talking about the June high, and making it more compelling, it lines up with a fair bit of monthly resistance shown by the blue trend line. In other words, if crude wants to move sharply higher, it must close above US$52.83 per barrel on 31 July. That would signal a breakthrough above the blue and green resistance levels.

Assuming this event takes place, which I believe is unlikely, crude could retest the 2015 high of US$69.60 per barrel. That’s shown by the pink projected trend line. In my view, there’s only one way that crude could re-test this high: global war must break out.

While I, unfortunately, believe that the world is heading towards another major global conflict, it probably won’t happen for several more months. Global tensions are rising. However, for war to break out, I expect the financial distress around the world needs to get worse. The European politicians are likely to save their banking system one more time, which means crude should see a new low in the months ahead.

If I’m right, you should pay attention to the black trend line. It shows support dating back to the 2015 low of US$42.20 per barrel. Brent bounced off that support this month, which implies that a monthly closing below US$46.67 per barrel — the June low — should signal a change in trend.

The warning is clear: lock in your gains. It’s better to be safe than sorry. Remember, unless there’s plenty of near-term exploration upside on the cards, you can always buy your oilers back later.

As long as the future remains uncertain, I suggest checking out three stocks that you can find in my free report, ‘Three ‘Bounce-Back Mining Belters’ to Buy NOW’. In my view, there are no better three stocks to own this year.

To get your FREE report today, click here.

Regards,

Jason Stevenson,
Resources Analyst, Money Morning

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