Why $40 Oil Is A Real Possibility

U.S. West Texas Intermediate and international-benchmark Brent crude oil futures are in a position to finish the week sharply lower as well as natural gas futures which pierced the psychological $2.00 level earlier in the week, seemingly on its way to the multi-year low of $1.60.

The catalyst behind the selling pressure is the concern that a virus in China may spread, hurting travel and fuel demand. China is the world’s second-largest oil consumer so any slowdown in travel would show up on its demand forecasts.

This news is overshadowing OPEC and its allies’ cuts in supply and an unexpected drop in U.S. weekly inventories.

Threat of Coronavirus Spreading

The deadly pneumonia-like coronavirus was first identified on December 31 in the Chinese city of Wuhan in Hubei province. It has since spread beyond Wuhan, which has a population of 11 million, to other major cities such as Beijing, Shanghai, Macao, and Hong Kong.

Multiple cases of the virus has been confirmed in Thailand, Vietnam, South Korea and Japan, while the United States, Taiwan and Singapore have each reported one case

Multiple Lockdowns Should Pressure Demand

As of Friday, 10 cities were put under lockdown measures with a total of about 33 million people. Transportation services in Wuhan, the epicenter of the virus, were shut down on January 23 and people were asked to not leave. The airport and train station in the city were also temporarily closed.

Other cities under lockdown include Huanggang, Xiantao, Exhou, Qianjiang, Zhijiang, Chibi and Lichuan. The combined population in those cities is approximately 24 million people. Authorities have also canceled Lunar New Year events in Beijing and other places. Airlines and rail operators are offering, refunds on domestic flights and train tickets around the country.

The cancelation of transportation and travel opportunities should have an impact on crude oil demand.

World Health Organization Calms Traders, but Short-Term Outlook Still Bearish

Fear and uncertainty from the spread of the virus could lead traders to further reduce long positions and generate more short positions ahead of the weekend.

Furthermore, with more than 30 million people quarantined in China, demand for energy is already dropping and likely to continue to move lower if the problem spreads throughout Southeast Asia.

On Thursday, the World Health Organization calmed crude oil traders when it said the coronavirus is not an international emergency yet. This means that traders are primarily concerned about it impact on regional demand in China. If the problem becomes a global emergency and international travel comes to a standstill then look for prices to drop further until they hit a value area where supply meets demand. The current price action and historical chart patterns suggest we haven’t reached that area yet, which could be in the low $40 area.

US Energy Information Administration Weekly Inventories Report

Some of the selling pressure on oil was reduced on Thursday after weekly data from the U.S. Energy Information Administration (EIA) showed that U.S. crude supplies fell by 400,000 barrels for the week ending January 17. Analysts were looking for a drawdown of 100,000 barrels to a 500,000 barrel build. Earlier in the week on Wednesday, the American Petroleum Institute reported an increase of 1.6 million barrels.

The EIA data also showed a supply build of 1.7 million barrels for gasoline, but distillate stocks declined by 1.2 million barrels. Traders were pricing in an increase in supplies of 3.3 million barrels for gasoline and 1.6 million barrels for distillates.

Technical Analysis

Weekly March West Texas Intermediate Crude Oil Technical Analysis

Weekly Trend indicator

The main trend is up according to the daily swing chart, however, momentum has shifted to the downside with the confirmation of the closing price reversal top from the week ending January 10.

We said at the time the reversal top was forming that if confirmed, it could lead to the start of a 2 to 3-week correction. The week-ending January 31 is week number three so we should keep an eye out for bottoming action. We’re not saying to pick a bottom, we’re saying to pay attention to intraday and daily chart patterns that start to indicate the buying is greater than the selling at current price levels.

We’re in a news-driven, bearish downside momentum market so it doesn’t make sense to step in the way of the selling just yet. If there is going to be a bottom on the weekly chart, then it is going to set up on the short-term charts first.

The main range is $71.83 to $45.76. Its retracement zone at $58.80 to $61.87 is now resistance. It is still controlling the longer-term direction of the market.

The short-term range is $45.76 to $65.40. The market is currently testing its 50% to 61.8% retracement zone at $55.58 to $53.26. This is a potential value area so if we’re going to see buyers re-emerge then it’s likely to occur inside this area.

Weekly Trend Indicator Forecast

Remember that with the trend up, buyers will be looking for value and support. The short-sellers received a gift with the virus triggering long liquidation. The buyers will also be looking for a gift with the opportunity to re-enter the market at levels not seen since OPEC and its allies agreed to increase their production cuts.

Based on this week’s price action and the current price at $54.51, the direction of the March WTI crude oil futures contract the week-ending January 31 is likely to be determined by trader reaction to the short-term 50% level at $55.58.

Bearish Scenario

A sustained move under $55.58 will indicate the presence of sellers. This could trigger a break into the short-term 61.8% level at $53.26. Watch for a technical bounce on the first test of this level, but if it fails, there could be an acceleration into $50.18 to $50.08.

Bullish Scenario

Overcoming and sustaining a move over $55.58 will signal the return of buyers. Depending on how aggressive they are, we could see a retracement back to $58.80 over the near-term.