Crude Oil Stalls Under Critical Resistance Level

• NYMEX oil futures come within 57 cents of an upside target

• The crude oil futures market faces bullish and bearish forces

• OPEC+ becomes more influential after the US power transition

• A pullback would not be a surprise

• Surprises are likely to come on the upside

We learned that markets can decline to illogical levels on April 20 when nearby NYMEX crude oil futures fell below zero and to under negative $40 per barrel. Crude oil futures recently came close to a critical technical resistance level on the now active month March futures contract.

The path of least resistance for the crude oil price is a function of many factors. Fundamental supply and demand pressures impact the energy commodity’s price. Term structure or the forward curve often provides clues about supplies. When they tighten, the curve moves towards backwardation, where nearby prices command a premium to prices for deferred delivery. Quality and location spread like the differential between Brent and WTI can shed light on demand. Processing or crack spreads also tell us about the requirements for oil products, which are consumer products that reflect economic conditions. Technical factors, such as momentum and trends, are excellent guides for the herd behavior that highlights the wisdom of the crowd. When buyers become more aggressive than sellers, prices tend to move higher and vice versa.

As we head into the second month of 2021, the crude oil futures market will begin to look forward to the spring season and the start of the driving season in the US when gasoline demand begins to rise. The global pandemic continues to hang over crude oil and markets across all asset classes in early 2021, adding another dynamic to making price projections. Over the past weeks, crude oil stalled just below the level that would provide another bullish technical validation of the trend that has been in place since late April 2020.

The United States Crude Oil Fund (USO) tends to move higher and lower with the price of a portfolio of NYMEX crude oil futures contracts.

NYMEX oil futures come within 57 cents of an upside target

The most recent high in the nearby NYMEX crude oil futures contract came on January 13 at $53.93 per barrel.

Source: CQG

As the chart highlights, the first level of technical resistance facing WTI crude oil futures is at the mid-February 2020 high at $54.50 per barrel. The price came within 57 cents of the level. At the end of last week, nearby futures were at the $52.20 level and were hanging around the recent high as the price consolidates.

Open interest has moved higher with the price of the energy commodity. The total number of open long and short positions rose from 2.039 million contracts on November 2 when the March futures contract hit a low of $35 per barrel. On January 28, the open interest metric was at 2.339 million contracts, 14.7% higher with the price at the $52.20 level, over 49% higher than at the start of November. Increasing open interest as the price rises is a technical validation of a bullish trend in a futures market. Weekly price momentum and relative strength indicators were in overbought territory and flatlining at the end of last week, while daily historical volatility declined from 50.53% on November 2 to the 26.8% level.

The crude oil futures market faces bullish and bearish forces

With crude oil flirting with another technical level that could launch the price higher and towards $60, bullish and bearish factors pull the energy commodity in opposite directions.

The rising number of coronavirus cases continues to be the most significant bearish factor for crude oil as it weighs on the fundamental equation’s demand side. The overbought technical conditions on the weekly chart are a sign that a correction could be on the horizon.

We are also in the heart of the winter season in the US, which tends to be a time of the year when the oil market experiences weakness. Stock market volatility tends to be bearish for the oil price.

Meanwhile, optimism that vaccines will create herd immunity has been a bullish factor for the oil market. The one million barrel per day surprise production cut from Saudi Arabia supported the price and was a sign that pricing power is shifting back to the Middle East and Russia as US energy policy moves towards support for a greener path of alternative energy sources under the Biden administration. OPEC+ always seeks to deliver the best possible return for its members, which translates to higher crude oil prices.

OPEC+ becomes more influential after the US power transition

Increasing energy regulations in the United States are on the horizon. At the start of his term in office, President Biden rejoined the Paris Climate Accords and canceled the Keystone XL pipeline project. On the campaign trail, the President pledged to reduce hydrocarbon production and consumption in the US. With Democrats in the majority in the House of Representatives and a slim margin in the Senate, energy policy will dramatically shift from the past four years. The administration will seek to ban fracking on federal land and install a regulatory regime that causes production costs to increase and output to decline.

The US became the world’s leading oil-producing nation over the past years, with daily output rising to a record 13.1 million barrels per day in March 2020. We are not likely to see that level of production again any time soon. We could see production decline because of increased regulations at a time when the world emerges from the global pandemic. At the end of last week, the EIA reported that daily output was at the 10.9 mbpd level. As people begin to travel and businesses get back to normal, the energy demand will increase. As US output decreases, OPEC and Russia will step in to meet the world’s requirements. The US remains a massive petroleum consumer, so higher prices could be on the horizon if the US needs to import crude oil over the coming months and years.

Moreover, the tidal wave of central bank liquidity, a tsunami of government stimulus programs in the trillions, and a falling dollar are all highly inflationary and bullish for the price of crude oil and all commodities. The bottom line is that falling US output hands the power baton in the oil market back to the Saudis and Russians.

A pullback would not be a surprise

From a technical perspective, the crude oil price is stalling below the $54.50 resistance level. Above there, the next level stands at $60 and then at the 2020 $65.65 high. However, the longer nearby NYMEX crude oil futures sit below the $54.50 level, the higher the odds that selloff will hit the oil market and test the $50 level or lower. The fate of the oil market could rest with the stock market. A continuation of the corrective move in equities last week could lead to selling in the oil arena. With stocks still near all-time highs, the odds of a correction remain high.

Surprises are likely to come on the upside

While a crude oil selloff could be on the horizon, I would buy the dip in the energy commodity. Any shocks are likely to come on the upside for four critical reasons, including:

• Liquidity and stimulus are inflationary, which is bullish for all commodity prices.

• Iran remains a clear and present danger in the Middle East. US relations with China are at a low point, and Russia is facing internal turmoil. Crude oil tends to rally during periods when the geopolitical landscape becomes turbulent.

• Falling US production puts the power of pricing in the hands of OPEC+. The cartel’s focus is the highest possible price.

• As vaccines go into arms worldwide, the economy will slowly return to pre-pandemic demand levels, supporting the price of the energy commodity.

The bottom line is that the path of least resistance for crude oil remains higher. The trend is always your best friend in markets, and since March and early November, crude oil has been in bullish mode. The potential for any surprise seems to be on the upside. Iran has pledged revenge for the murder of its top General and a leading nuclear scientist. I expect lots of volatility in the crude oil arena over the coming months. Any selloff is likely to be a buying opportunity so long as the stock market remains stable.

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The United States Oil Fund (USO) rose $0.49 (+1.39%) in premarket trading Monday. Year-to-date, USO has gained 7.69%, versus a -0.17% rise in the benchmark S&P 500 index during the same period.

USO currently has an ETF Daily News SMART Grade of D (Sell), and is ranked #71 of 112 ETFs in the Commodity ETFs category.