Complex Made Simple

Volatility continues in oil – can it make a recovery?

It would be an understatement to suggest that the last couple of weeks for the oil markets have been anything but volatile. After an eventful conclusion to May following the highly-anticipated OPEC meeting, the commodity once again crashed into another bear market.

Its valuation dropped from $52 to a record 2017 low of just below $42 – this drop in price came on the heels of a previous dip in early June, when President Trump decided to withdraw from a climate pact that raised fears of more US drilling and increased stockpiles.

What happened to the oil markets after the OPEC meeting is another example of how investors ‘sell the news’, with an outcome already priced in before the event takes place. The question to ask now is, can the price of oil make a recovery in July?

My own view is that yes, it could make a significant recovery this month because the entrance into another bear market suggests that the commodity is now completely oversold. I also believe that the technicals support the view that oil may be in line to recover its momentum after its failure to conclude weekly trading below $42 at the end of June.

While $42 still represents the 2017 low, it is seen as a psychological support level and technical traders would need to see the commodity conclude trading below this level, to be enticed into pricing in a potential downward trend towards $40.

To what level could the price of oil recover? $47 looks to be in reach, but $48.50 is going to be viewed as a stubborn resistance area before we can talk about the prospect of oil returning to $50.

Overall, I maintain that the commodity should consolidate around the $50 region, during the second half of the year, but we need to be mindful that the level of volatility around oil remains very high. Investors stand ready to add speculative positions very suddenly, and this may result in some volatility in price action.

The reason the price of oil is so sensitive to sudden fluctuations, is because of the changing dynamics around the oil industry.  OPEC used to be in control of the overall market share in terms of production, but that has changed in recent times and OPEC no longer has a controlling influence over the market.

New players have emerged in terms of production, which many will attribute to the United States and the evolution of Shale. While it is true that the US has emerged as a serious power when it comes to output, it is not the only contributor to ongoing oversupply.

With the unyielding oversupply dynamics weighing heavily on the minds of investors, and with it becoming clearer that OPEC no longer has the influence over the industry it once did, oversupply will continue to be the name of the game when it comes to oil.

This also means that the efforts being made by OPEC to regain market share, are in danger of being offset by producers outside of its production pact. Two nations that received exemptions from joining the agreement to cut production output were Libya and Nigeria, which have both increased inventories recently and are now seen as a threat to removing the excess supply OPEC was hoping to cut from global stockpiles.

I would keep a closer eye on increased inventories from Nigeria and Libya than Shale production in the United States, as I feel this has already been priced in. I also believe that US Shale producers will start to suffer, with oil recently falling towards $40 and drilling activities set to make a U-turn, US inventories will start dropping at a faster pace as we enter the summer months.

This should support prices, but we need to be aware of how investors react to any news around increased drilling elsewhere. This hasn’t yet been priced into the markets, and a technical close below $45 later on might open the door to a return to a low of $42.