The Bleak Outlook For Crude Prices

Marius Paun | London, UK | Senior dealer | Thursday, 24th September 2020

The commodities spectrum as a whole has performed rather well during the past few months (if you discount the last few weeks, especially in the precious metals). However, one asset has gone nowhere, crude oil. Let’s look at possible reasons why?

The first reason that springs to mind is obviously the Covid-19 pandemic. As the world went into lockdown for a few months, movement outside was seriously restricted, which means driving was also limited. That in turn destroyed the demand for fuel. Going on holiday also became a challenge due to quarantine measures. It explains why airlines and cruise operators were among the worst hit and are still struggling to stay afloat.

Oil was already going out of fashion especially with the young generation keen to replace it with cleaner energy. Electrification seems to be the way forward – see Tesla, the new candidate ready to challenge to FAANG lot. Self-driving electric cars are not future projects anymore. We’ve all seen them. They’re here, even if not on a large scale yet, and are ready to take over the way we move around.

The figures for cars registrations in the UK for the second quarter of this year show that for the first time electric and hybrid cars have outpaced the number of diesel cars. Even allowing for a significant hit in cars sales due to coronavirus, this looks like a trend that will be close to impossible to reverse, showing the direction for an entire industry.

Back in spring, we learned about Saudi Arabia and Russia being involved in an oil price war. There was plenty of speculation on the subject. It appeared that both tried to put US shale producers out of business as both have lower costs of production. Did they achieve that? Yes, a few drillers went out of business, but they did not kill the whole industry. It is testimony to the shifts in the geopolitical map once the US has become a major oil producer. OPEC+ appears to have a lot less influence than a few decades/ years ago.

So even if crude demand took a hit from an unexpected event, supply looks much better than a few decades back simply because technology allowed the producers to get better at getting oil out of the ground.

On the short to medium term let’s not forget the US elections; Trump versus Biden. At the moment the majority of polls indicate that Biden has a 7% -8% edge. That does not mean much as the last elections showed. The markets seem to prefer Trump though because of Biden’s threat of higher taxes. Trump is seen as more friendly towards the traditional oil producers, already mentioning plans for fewer regulations for them. But he could lose and Biden favours a Green New Deal. In that scenario, oil could get another significant blow.

Last but definitely not least is the US dollar. After a few months of ongoing weakness, the greenback is currently enjoying a pullback due to worries of a second wave of coronavirus. As commodities are expressed in US dollar, that should add some headwinds for crude oil.

There’s no doubt that investor sentiment is strong against the traditional energy sector right now which together with banks and hospitality are among top laggards. But that’s exactly why even if they have zero momentum, oil stocks may represent good value. Some point out that from time to time the contrarian argument will have its day. Peak oil demand predicted by BP recently does not mean global oil consumption will just evaporate. Oil producers might just shift to clean energy in droves and supply could go down even faster than demand. The world will still need oil for quite a while so in that scenario a comeback for crude prices does not look far-fetched anymore.

The chart above shows the short-term moving averages about to cross below the longer-term moving averages after a brief rise. Furthermore, it seems the short-term MA (6 day) is pointing downwards again. Yes, the short term is down but the medium is more of a sideways pattern.

On the upside, bulls would need to see a close above resistance at psychologically important $40.00 mark first. That would bring into focus $40.78 followed by $41.5. Undoubtedly buyers will hope momentum can carry them for a test at $ 43.6. If that is successful the medium-term trend will shift to bullish. On the downside, bears will have their eyes on breaching support just above $39.00 handle first. A close below that level could attract additional sellers who will challenge $37.30.