…And the OPEC+ might address some of the supply risks next week.
Crude oil turned lower on Tuesday as investors shunned risk after the technology sector led a big sell-off in the equity markets. This morning, prices initially fell further before turning positive again. European equity markets also stabilized somewhat ahead of the US open. The key question as for as crude oil concerned is whether prices have reached at least a short-term top or this is just a pause before we see more gains. My personal view is that I cannot see crude oil prices rising significantly further from here and reckon the risks are skewed to the downside.
Why oil has rallied
In the US, production dropped due to the impact of the hurricane Ida, causing stockpiles to shrink. Inventories have actually declined across the world amid supply shortages and stronger-than-expected demand growth. Crude has also been supported by the fact the energy sector has been rallying across the board. Scorching hot weather in parts of Europe caused demand for cooling to surge, which, in turn, increased natural gas demand by electric power plants, causing inventories to plummet. As gas prices rose, some factories halted production of things like fertilizers while some switched to oil-fired power generation, boosting demand for crude. Expectations that more companies will turn to oil for power generation has helped to fuel the rally in crude prices.
Oil prices face major headwinds
While oil has had a great year so far, that’s not to say prices will continue rising, as the market is always forward-looking. Looking ahead, I see some potential obstacles that could derail the rally. So, I reckon that the risks are skewed to the downside for oil prices. Some of the reasons why I think that might be the case are listed below:
- Emerging market currency crisis is already being felt in places like Pakistan and Turkey. India could potentially be next. India is the world’s third largest oil importer and consumer, meaning that if the dollar rises against the rupee, it would hurt demand for oi and other commodities as the strength of USD would make imports even dearer.
- Signs of weakening economic growth in China and the fact they have tapped their strategic reserves indicate demand from the world’s largest oil importer is already negative signs of oil.
- Supply bottlenecks could undermine the economic recovery in more developed economies.
So, the net result of the above: potentially weaker demand growth for oil in the months ahead and thus lower prices.
What’s more, oil prices have shown the first glimpse of responding to the ongoing risk-off sentiment observed in the stock and FX markets with technology shares tanking and US dollar surging against commodity dollars, emerging market currencies, as well as the pound and euro.
With Brent briefly topping $80 a barrel, it looks like investors are realising that oil prices have gotten too strong. It is difficult to justify such prices when stagflation risks are on the rise and there is the potential for the OPEC+ to ramp up its production and allow more barrels to hit the global market to prevent demand from collapsing. As mentioned, demand from India and other major oil-importing nations could suffer as EM currencies weaken against the rapidly-appreciating US dollar.
Tentative bearish signs for Brent
Finally, from a technical point of view, Brent briefly poked its head above the $80 hurdle on Tuesday but the fact it couldn’t hold there caused a bit of selling which eventually saw prices drop to create a bearish-looking candle on the daily. Time will tell whether this will turn out to be a significant signal. More support levels need to break down for confirmation that prices have topped out. For now, Tuesday’s price action is just a warning sign.
Source: ThinkMarkets and TradingView.com
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