The recent Middle Eastern tensions sparked an oil rally. Is it enough for a true comeback?

Marius Paun | London, UK | Senior dealer | Wednesday, 08th January 2020

Last December OPEC+ alliance (OPEC and non-cartel member Russia) agreed to cut oil production by an additional half a million barrels a day. Saudi Arabia, the biggest OPEC producer, accepted a further reduction of 400,000 barrels. Together with previous cuts, the market saw in excess of 2 million barrels being taken off the table in 2019 alone, from the total produced the previous year. The initial reaction was indeed a spike higher, of around 2%, in crude prices, but in the following sessions, the sentiment looked muted. The headlines were again ‘no one cares about crude anymore’.

It was reminiscent of the drone attacks on the Saudi refinery back in September same year. Crude prices surged initially, only to retrace within weeks and actually move below the level seen at the time of aggression. So, on one hand, OPEC got cold feet regarding the oversupply amid the US becoming a net exporter for the first time since 1978 (according to US government data). The US shale oil production was portrayed as a big contributor to that shift. On the other hand, there are increased concerns that a US-China trade war, as well as what seems to be a step back from globalization, will reduce the global oil demand even further.

But perhaps to understand why oil prices are so out of fashion is better to look at some statistics.

The Financial Times showed that the market capitalisation of Apple has recently surpassed the entire S&P 500 energy sector (roughly $1.1 trillion) comprising of 28 companies. CNBC reported that the S&P 500 energy sector was ‘the worst performer of the last decade’ up an anaemic 5% compared with 180% gains for the whole index. Furthermore, energy presently has a weighting of just 4% in the S&P 500 versus more than 13% in 1990.

Despite seeming so apparently “out of fashion”, crude oil prices soared 3% last Friday after the US killed Iran’s most powerful military commander, Qassem Soleimani, in an airstrike in Baghdad. Concerns were raised of a bigger conflict between the two nations (already at serious odds) that could disrupt oil production and send prices even higher. That’s because Iran controls the Strait of Hormuz and has repeatedly threatened to shut it down.  The strait of Hormuz is a strait between the Persian Gulf and the Gulf of Oman providing the only passage to the open ocean. The fact that around 20% of global oil passes through it every day makes it a strategic point for international energy trade.

On the flip side, the financial press is awash with the views that past conflicts in the Middle East have attracted a more sizeable spike in crude prices, suggesting that the aforementioned US shale driven oversupply has triggered a limited interest towards tensions in the Gulf region. On Monday the US oil prices surged above $64.69, a level was last seen in April last year but ended the day lower. It could be that despite the escalation in the tension between the US and Iran, the oil supply in the region has not been as disrupted as originally feared. It mattered less that US President Donal Trump vowed to impose heavy sanctions on Iraq if American troops are forced to leave, Or that 50 Iranian sites could be hit if Tehran retaliates.

Somewhat as expected, last night Iran retaliated by hitting the US military bases in Iraq in a rocket attack. It is unclear yet the level of, if any, casualties, but so far there are no reports of any disruption in the oil supply. It appears Iranians did not target any major energy infrastructure. That’s possibly the reason why US crude prices jumped overnight to a recent high of $65.62 but ultimately drifted back down to below $62 a barrel at the time of writing. It’s still too early to conclude if a wider scale conflict was indeed averted. After all, Donald Trump tweeted ‘All is well and assessment of damages is taking place now’.

Let’s take a look at the long-term chart:

The momentum now is with the bulls as indicated by the moving averages. The short-term MA (red line) has crossed above the longer-term one (blue line), both are pointing upwards and the price is above them.

On the upside, a sustained move above $63.6 which is 61.8% Fibonacci retracement will indicate the increasing buying power. This morning the next target just above $64 was reached but it attracted a sharp pullback. That move needs to be confirmed is the uptrend is to continue. Bulls will undoubtedly look to $66.57 the high of 21st of April last year. Overcoming that hurdle will shift the medium-term trend to bullish as well.

On the downside, the immediate target is just below $61 and a test is imminent. A move below that mark will signal the presence of sellers. If that downward move brings enough momentum than the pullback could extend to $59.80 – the 50% Fibonacci retracement. Support at $58 is the next target for the bears.