Oil Fundamental Analysis – Forecast for the Week of October 3, 2016

Crude oil futures rallied last week after OPEC agreed to cut output in an effort to reduce the world’s supply glut. The announcement of the deal on Wednesday, September 28 surprised traders, triggering a massive short-covering rally that drove the market into its highest close since September 8.

The November West Texas Intermediate Crude Oil futures contract finished the week at $48.24, up $3.76 or +8.45%. Earlier in the week it touched a low of $44.19. November Gasoline prices benefited from the news with a rally of its own. The futures contract finished the week at $1.4631, up $0.1074 or +7.92%.

Hedge funds were heavily short going into last week’s informal talks held by OPEC and other large exporting members at a meeting in Algiers, leading traders to suspect that it was short-covering rather than new buying that drove the futures contract sharply higher. We’ll find out who was actually behind the move when we get to see the latest Commitment of Trading report from the U.S. Commodity Futures Trading Commission.

If the hedge funds held their ground then we could see another round of selling pressure since they are likely to come back in to defend their positions.

Although on paper the decision to cut output sounds bullish, it is actually a difficult process. OPEC has made it difficult because of the number of countries involved that have to reduce their output. Negotiations will have to take place inside the cartel to determine which countries will cut and by how much. The negotiation process is very important to the structure of the deal and has led to failure of previous efforts to curb output and boost prices.

FORECAST

The direction of the crude oil market this week will be based on an equal balance between the technicals and the fundamentals. Technically, the price action will be all about whether the buyers can sustain the momentum created by last week’s rally and how they react to the recent tops at $48.38 and the psychological $50.00 level. As traders, we’re going to have to figure out if the buying is real or just short-covering.

If it’s just short-covering then this will signal that the buying is weak and that the market is likely to correct back into a value area over the near-term.

Some traders are skeptical about whether OPEC will be able to implement this deal. It may be able to negotiate its member output cuts, but it will not be able to dictate policy for U.S. producers. They are likely to ramp up production and go after market share. Essentially, an oil price rally caused by OPEC production cuts would benefit U.S. shale producers, who have been cutting back during the past two years but have been steadily adding drilling rigs.