The Long-Term Effects Of A Crazy Week For Oil

It has been a busy week for oil traders, and indeed for anyone that follows energy markets and stocks. When news of a drone attack on Saudi oil facilities on Saturday broke, futures surged over nine percent. Then, on Tuesday, when the Saudis claimed that output would return to normal and President Trump talked of the U.S. releasing strategic reserves to stabilize the market, crude gave much of that back. That kind of short-term, news-driven volatility is worrying for traders and investors, but now that the dust has mainly settled, what does it mean for oil?

From both a fundamental and technical perspective, the events of this week have changed the picture dramatically. Even after Tuesday's retracement, crude futures remain well above Friday’s closing level, and for good reason.

There is a good chance that the Saudis could be overly optimistic in their assessment of the damage, but even if they aren’t, the attacks accentuate a risk factor that the markets had been largely ignoring before last week. Tension in the Middle East is nothing new, so some degree of potential disruption is always priced into oil, but the situation now is riskier than usual for several reasons.

The Saudis and Iranians have been involved in proxy wars in both Yemen and Syria for a while. The massive toll in blood and treasure taken by that kind of conflict makes escalation always possible as desperation increases, but the current situation of Iran makes it almost inevitable.

When the U.S. pulled out of the Iran nuclear deal, it had several destabilizing effects. The sanctions on the country pushed them into a corner, leaving them feeling they had nothing to lose by being aggressive. It also increased the power of the extremists there, who have said all along that the Americans weren’t to be trusted and that the deal was a mistake. More worryingly from an international perspective, it also allied the U.S. even closer with Saudi Arabia, raising the specter of increased U.S. involvement in the region.

All of those factors had been in place before Saturday’s events, but the nature of the attack changed their potential impact. The effectiveness of targeted drone strikes allows the Iranians, as weak as they are, to inflict real damage, and the success of this operation will surely encourage more. One could argue that this attack was a function of just that kind of encouragement, as it wasn’t the first of its kind. A similar attack a month ago received a lot less publicity as oil supplies weren’t affected, but the fact that another could be launched successfully a month later shows how vulnerable the Saudi oil fields are.

From a market perspective, there don’t even have to be successful attacks in the near future to keep oil prices elevated. Just the factoring in of the heightened risk will provide support, especially given the technical outlook.

Monday’s move did two significant things. It broke crude out of a bearish trend pattern (white lines on the chart above) and pushed it above both the 50-day (yellow line) and 100-day (blue line) moving averages. If prices hold above the 100-day for a while, which looks likely right now, we will see the 50-day pass it in a classic “golden cross”, a very bullish sign, before too long.

Unless we move back below the 50-day average, an unlikely thing given the renewed focus on geopolitical risk, oil will, therefore, settle into a new, higher range as the year draws to a close. If so, we are at the bottom of that range and positioning for a sustained move higher makes sense.