December 15, 2014    3 minute read

Can Crude Oil Rally?

Can Crude Oil Rally?

Since the week beginning June 16th, where crude oil was trading at $107.73, there is perhaps only one way in which to describe what has happened since: catastrophic. The bearish, violent turn in the market commenced in June, but started to pick up snowball-esque momentum in October; and has since dropped 40%. Crude futures on the New York Mercantile Exchange logged a new 5-year trough after dropping another 4% last Friday, trading at $63.44 a barrel.

In the wake of OPEC’s recent meeting, where oil production levels were left unchanged, oil prices fell a further $10 per barrel. However, there are signs that a rebound could be just round the corner. Unlike when oil cascaded in 2008, the US economy is showing positive signs of continued growth through last weeks job report showing that in November the USA created 321,000 jobs; the most in just under three years. This, coupled with the ECB stimulating the economy and the call for higher interest rates, saw the USD index at a new high on December 5th at 89.55. The inversely proportional relationship between USD and the WTI can be seen below.

The stagnant Chinese economy may also help provide a floor to the plummeting oil prices, and perhaps a 40% fall in energy prices is what China needs to gets back on track and continue its proven growth over the past decade. From a technical perspective, the volume of crude futures traded has declined from 800,000 to 500,000 over the past few months. In addition to such, crude oil has gone from a state of backwardation (where nearby futures are more expensive than deferred futures) to contango (the converse), which shows momentum is slowing and the market predicts oil prices to rise in the near future.

The Saudis, along with many of the other large oil-producing nations, have blamed US production for the current low oil prices. Their argument is valid; due to increased production from the US, there is a surplus of crude oil available which has driven the price down. However, the market may be surprised by the possible demand coming from China and the US itself due to low oil prices giving many economies and industries a chance to gain some traction.

Once these factors are taken on board, perhaps the demand side of the equation will outweigh the supply side enabling crude to stop in its tracks and climb back to pre-OPEC meeting prices; there is potential for the price to rise to $70-80 dollars a barrel by Q2 2015, in contrast to the views of many analysts in the City who stand by their word to continue to maintain a short position.

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