Oil Fundamental Analysis – Forecast for the Week of October 10, 2016

Crude oil futures rose sharply higher last week as investors continued to increased bets that OPEC will actually follow-through with its September 28 proposal to cut production. November Crude Oil futures finished lower on Friday, but higher for the week at $49.81, up $1.57 or +3.25%. This puts both Brent and West Texas Intermediate Crude Oil up about 10 percent since OPEC announced its first production cut plan since 2008.

Bullish traders claim OPEC is back to taking control of the price of oil. One hedge fund manager went as far as saying the OPEC is “back in business” of determining oil prices and only a “brave person” would bet against the cartel.

OPEC is also moving forward to smooth out the details of the proposed production cuts by scheduling meets between OPEC energy ministers and Russian officials in Istanbul on October 9-13.

At stake is the cartel’s plan to bring its output down to 32.5 million to 33 million barrels per day, cutting about 700,000 bpd from a global glut estimated by analysts at 1 million to 1.5 million bpd.

Bearish traders are saying that the current rally is all technically based speculation and the oversupply numbers will eventually prevail. Furthermore, the market is overbought by most technical signals, making it ripe for profit-taking and aggressive selling pressure.

These traders are also casting doubts as to whether OPEC will get all of its members to agree to the production cuts over time in order to put a dent in the oversupply.

Furthermore, the price rise demonstrates the growing disconnection between the speculative market and the real market. In the real market, top exporter Saudi Arabia cut its benchmark crude prices to Asia last week. This is a sign of ongoing oversupply.

FORECAST

This week’s price action will largely be influenced by technical factors since the deal is still speculative and the market begins the week in a technically overbought position. Furthermore, Friday’s higher-high, lower-close may be suggesting the selling is greater than the buying at current price levels.

Fundamentally, investors will be watching Tuesday’s American Petroleum Institute report and Wednesday’s U.S. Energy Information Administration’s weekly supply and demand report to see if there is a break in the pattern of weekly consecutive drawdowns. The market may be due for a huge inventory build because of recent surprise drawdowns. This would give long investors an excuse to book profits.

Last week, there were signs that many U.S. shale oil producers have now hedged their production. This could mean that the upside potential for crude is limited.

Bearish traders will also be looking for signs of increased output from U.S. producers. Last week, Baker-Hughes reported the U.S. rig count rose by three to 428. The rig count has not dropped for 15 straight weeks, likely reflecting producers’ growing confidence as oil prices stopped going down. If oil prices can stabilize near the $50.00 level, we may even see a jump in the number of rigs coming back on line.

Barring a surprised in this week’s EIA supply/demand report, crude oil futures are likely to take a breather this week after a spectacular rally. The recent rapid rise did its job by taking out the weak shorts, now investors are likely to go back to the traditional fundamentals.

The announcement of the OPEC plan may have been enough to underpin crude oil, but I think it’s a little too early to sustain the rally. Prices are going to have to pull-back into a value area before moving higher because I don’t believe that hedge fund buyers are going to chase this market higher.