Crude oil prices break 2-year support but remain stuck in 4-year trading range
Although many of commodities rebounded slightly this week (such as copper, gold and silver), crude oil and the petroleum commodities in general kept sliding to new lows. Many are asking why and how low can oil prices go before they find support.
The initial drop in commodities, which began in July, was caused by a strengthening US dollar. This continued until last week dragging down all commodities including energy. However, the US Federal Reserve admitted this past week it is in no rush to raise interest rates in light of weakening economies around the world. This caused a small drop in the US currency and subsequent bounce in hard and soft commodity prices, such as copper, gold, silver, soybeans and coffee. However, crude oil kept falling. The likely culprit was the combination of record production numbers out of Russia, Saudi Arabia, Libya and the US, coupled with potential for even lower oil demand as Europe appears to be on the brink of another recession.
So how low can oil prices go? A long term view (as shown in the price chart below) clearly shows that crude oil has been stuck in a 4 year trading range, hovering between $80 and $110 per barrel. As of Friday's close, we are still in this trading range and will likely not break down unless the US dollar resumes strengthening and breaks out to new highs.
However, the short term support line of rising prices (formed over the past 2 years) clearly broke when we fell below $95 per barrel. It is therefore unlikely prices will rebound back about $95 anytime soon, barring any unforeseen major supply disruption (such as political unrest in Saudi Arabia, a Russian oil embargo or a powerful hurricane in the Gulf Coast).
So what does this mean for energy stocks? As noted previously, stocks tend to lead the commodity price. Since energy stocks were rising faster than oil prices during the first half of 2014, it would indicate a consensus among traders that crude oil prices will eventually rise further given the global turmoil and potential sanctions against Russia. However, this constraint in crude oil supply clearly did not materialize since Libya, Saudi Arabia and Russia all increased oil production last month and US inventories continue to rise to new highs. Coupled with increasing production in both Canada and the US (which is expected to continue for some time), traders clearly had a change of heart and are now convinced that the oil markets are seriously oversupplied and in no danger of supply disruptions. Funds are therefore coming out of energy stocks as quickly as they piled in before the summer began.