This Oil Rally Won’t Last

Barring any steep jump the rest of the session on Friday, prices are heading for their eighth weekly loss in the last nine, one of the most volatile weeks in the history of oil trading, with nearby expiring May U.S. West Texas Intermediate falling into negative territory to minus $37.63 a barrel on Monday, while Brent fell to a two-decade low.

Traders are saying the late week rally is being fueled by short-covering rather than speculative buying. Nothing has changed in the fundamentals to turn the energy complex bullish the last three days. Once the coronavirus is under control, output should rebound as well as prices, but don’t expect output or prices to return to pre-virus levels for years.

Week Began With Extremely Bearish Outlook

Excess supply caused by the economic fallout from the coronavirus pandemic hammered crude oil at the beginning of the week. 

The selling pressure was so strong, the front-month U.S. futures contract fell into negative territory for the first time in history and set a record for the number of contracts traded on Tuesday. The surge in volume and volatility prompted the CME Group, the world’s biggest commodities exchange, to raise margins on crude oil futures.

Coronavirus Inflicted Demand Destruction

Crude oil prices have plummeted by close to 80% this year as the pandemic has spread across the world and every sector of the economy, killing nearly 180,000 people, routing financial markets and leading to potentially the worst economic meltdown since the depression of the 1930s.

The viral outbreak has caused fuel demand to drop by roughly 30% worldwide and energy companies in the United States, the world’s biggest producer, are scrambling to find storage for excess oil.

“This is a direct result of excessive investment coinciding with a sudden demand shock in a landlocked area with limited storage and transportation,” Goldman Sachs said in a report.

Concerns about the collapse in demand because of travel restrictions to contain the coronavirus and a shortage of space to store oil are expected to dominate the news over the near future. However, do not expect a repeat of Monday’s price shock, which saw traders paying buyers to take crude off their hands given a lack of storage space for the current supply glut.

Rising Tensions in Middle East Threaten Supply

After June futures hit $6.50 per barrel and the nearby futures contract went off the board, prices rose in reaction to an announcement from President Donald Trump in which he instructed the U.S. Navy to fire on any Iranian ships that harass it in the Gulf, although he added later he was not changing the military’s rules of engagement.

“This ratchets up tensions once again between the U.S. and Iran. However, given the glut we have in the oil market, it is difficult to see this offering lasting support to the market, unless the situation does escalate further,” ING’s head of commodities strategy Warren Patterson said.

First Signs of Production Cuts

Output cuts by producers also supported prices late in the week.

Kuwait’s state news agency KUNA said on Thursday the producer will begin cutting supplies to international markets without waiting for the official start of the OPEC+ deal on May 1.

Additionally, Azerbaijan’s Azeri-Chirag-Guneshli oil project will have to cut output sharply from May onwards as the oil producer fulfills its commitments under the deal to cut production, four sources told Reuters.

Additionally, Russian oil companies will cut their crude oil loadings from Baltic ports and Black Sea’s Novorossiisk in May to 5.42 million tonnes, the lowest level in 20 years, the preliminary loading schedule seen by Reuters showed on Friday.

Technical Analysis      

Weekly June West Texas Intermediate Crude Oil

The main trend is down according to the weekly swing chart. A trade through $6.50 will signal a resumption of the downtrend.

The main trend will change to up on a trade through the last main top at $54.90. This is extremely unlikely, however.

The minor range is $34.04 to $6.50. Its 50% level or pivot is at $20.27.

The short-term range is $54.90 to $6.50. Its 50% level comes in at $30.70.

The main range is $63.73 to $6.50. Its 50% to 61.8% retracement zone at $35.12 to $41.87 is major resistance.

Weekly Technical Forecast

Based on this week’s price action, the direction of the June WTI crude oil futures contract the week-ending May 1 is likely to be determined by trader reaction to a downtrending Gann angle at $14.90.

Bullish Scenario

A sustained move over $14.90 will indicate the presence of buyers. If this move creates enough upside momentum then look for a surge into the minor pivot at $20.27. Since the main trend is down, sellers are likely to come in on the first test of this level. Overtaking it, however, could trigger an acceleration to the upside with the next major target coming in at $30.70.

Bearish Scenario

A sustained move under $14.90 will signal the return of sellers. The daily chart indicates there is plenty of room to the downside with the next downtrending target angle coming in at -$0.27.

Weekly Outlook

Prices could continue to firm next week if more OPEC+ members announce early production cuts. An escalation of military activity in the Middle East will be a bonus. However, the wildcard will be the announcement of output cuts by U.S. producers. This news could trigger a steep short-covering rally.

The demand destruction is expected to continue, but may slow down if the coronavirus curve continues to flatten.

From a technical perspective, look for a strong upside bias to develop on a sustained move over $20.27, and for the downside bias to continue on a sustained move under $14.90.