Crude Oil Could Be Closer to a Bottom: Here's How to Trade it

  • Commodities Analysis
  • Editor's Pick
  • Despite a recent oil price recovery, bearish momentum persists, fueled by doubts over OPEC's output cuts and US crude exports.
  • Seven weeks of declining oil prices have raised concerns about OPEC+ cuts, non-OPEC supplies, and economic challenges impacting global demand.
  • Oil's recent decline may find support around the $70.00 level, a significant psychological and historical point. Below it, $67, $65, and the May low at $63.64 act as reference points.

Crude oil started the new week on the front foot, continuing their recovery from the end of last week. But after seven consecutive weekly losses, the momentum was bearish and there was a good chance the early momentum would fade.

Still, the worst of the sell-off may be behind us after what has been a brutal couple of months. The ongoing supply cuts from OPEC and allies should keep the downside limited from here on. If anything, the risks are skewed to the upside from here, I believe.

Why have oil prices fallen so much?

Despite the bounce at the end of last week, oil prices still closed the week lower, extending the run of losses to 7 weeks. The descent follows the voluntary output cuts that were made by OPEC+ a couple of weeks ago, which left the markets unimpressed. The sell-off gained momentum as successive support levels succumbed, giving rise to more technical selling.

As well as doubts regarding the effectiveness of OPEC's recent output cuts, investors have also been concerned by the continuous growth in US crude exports, pointing to excessive non-OPEC supplies. The substantial daily export of nearly 6 million barrels of oil by the US puts pressure on OPEC+ members to relinquish more market share as part of their supply reduction agreement. Some members are rightly reluctant to further cut production, fearing the loss of market share to the US.

What’s more, fears about demand have also played a big part in the recent drop. The global economy remains stagnant due to elevated interest rates, while the lingering impact of past inflation spikes continues to negatively affect both consumers and businesses. The slow disinflationary process further exacerbates these challenges.

Can oil prices recover?

Despite these economic headwinds, though, the severity of the oil price decline may not be entirely justified, given the demand inelasticity nature of oil prices. In this context, the supply side of the equation holds more influence. If OPEC takes additional measures to stabilize prices, this could be a major source of support to prices. Recent remarks from officials in Saudi Arabia and Russia suggest the possibility of extending or deepening supply cuts beyond Q1.

Even without any further additional cuts from the OPEC+, they are already doing a lot in terms of withholding supplies. As demand recovers, prices should start pushing higher again. Already, one could argue that the extent of the sell-off is not justified giving the ongoing OPEC+ intervention.

Crude oil: Technical view

Ever since topping out at $95.00 in September, WTI has not looked back much. Oil prices went on to fall in October and November, and are down again so far this month. Prices have fallen for 7 consecutive weeks, and we have only seen two positive weeks in the last 12. The momentum has clearly been to the downside.

Crude Oil Price Chart

Therefore, we will need to see a confirmed reversal pattern before turning tactically bullish on oil prices, even though there have been tentative signs of a potential bottom at the end of last week when prices found strong support, when they briefly dipped to below $69 before recovering to close the week well above the $70 handle.

Moving forward, the $70.00 level will be the most important support to watch. As well as a key psychologically-important level, $70 was also the base of the last major rally that took place back in July and is where the support trend of the bearish channel comes into play. This makes it an even more important support zone, where we could potentially see prices bottom out. Below this level, $67 is the next reference point, followed by $65 and then the May low at $63.64.

In terms of resistance, the area between $72.35ish to $74.00ish marks an important zone. Here, oil prices had previously found support, before last week’s breakdown. Therefore, if we see the bulls recapture this important zone, then the probability that we have seen a near-term bottom will increase markedly. For extra confirmation, a clean breakout from the bearish channel is needed, though.

How to trade oil in these conditions?

When it comes to trading oil, until we see a clear sign of a reversal, the bulls may wish to proceed with extra caution, taking it from one level to the next rather than aiming for the moon.

Clearly, the momentum has been bearish, and holding onto long positions for a period of more than a couple of days has not been working since September. Even if oil has already bottomed out and goes on to rise further this week, it will give traders plenty of opportunities to get on board at a later stage. There should never be an urge to rush into any trades because of fear of missing out.

The bears, meanwhile, have had great success in driving prices lower in the last three months or so, by 27% from the highest point in September to the lowest last week. This is a massive move for any asset. While it does mean prices are now officially in a bear territory, you just have to wonder how much of the negative influences are already in the price now. So, from here, the losses could well be limited, as the bulk of the move may have already taken place. For the bears, this also means extra caution and from one level to the next.

All told, I am leaning more towards looking for bullish trade setups here than bearish, as I believe the bulk of the downward move has already taken place.

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Disclaimer: This article is written for informational purposes only; it does not constitute a solicitation, offer, advice, or recommendation to invest as such it is not intended to incentivize the purchase of assets in any way. I would like to remind you that any type of asset, is evaluated from multiple points of view and is highly risky and therefore, any investment decision and the associated risk remains with the investor.

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  • Emihle Ntingi @Emihle Ntingi
    Maybe recent Russo-Saudi meeting might push prices up higher hopefully in the short term
    Like 0
  • Franco Sibanda @Franco Sibanda
    interesting take and conclusion Fawad let's see what the future holds
    Like 0