Friday, October 9, 2020

Crude oil prices may have some short-term upside, but medium-term risks are skewed towards the downside

  • Oil
  • {$custom.WTI$}


Analysts’ Pick: Crude oil prices may have some short-term upside, but medium-term risks are skewed towards the downside

  • Oil may experience some immediate boost from optimism on stimulus and expectations of Hurricane Delta’s damage to oil production
  • However, medium-term fundamentals continue to skew the outlook for the crude oil prices towards the downside, especially with the market recently turning bullish on non-fundamental factors
  • Our longer-term outlook for oil remains mostly the same, i.e. a slow and gradual recovery in oil prices in tandem with the global economy, but it is also important to note that global oil players are starting to factor in an accelerated shift towards clean and renewable energy

Since our last report on oil in July, oil prices suffered a downward correction bringing Brent and WTI to as low as 39.79 and 36.58 a barrel respectively. In our view, the main drivers were the lack of additional stimulus measures in the US which led to a stronger dollar, increased supply from Libya restarting production facilities and seasonal factors starting to impact perception of demand for the rest of the year. While our long-term expectations for crude oil prices are still skewed towards a slow and gradual recovery as the global economy improves, a shift towards environmental policies from governments may limit the potential upside as compared to before. In the short-to-medium, we view volatility as a constant across financial markets including the crude oil market. But risks appear to be tilted the downside for oil prices, meaning that we may see crude oil prices continue in its current range with only a slight uptick before a possible downward correction.

Crude oil prices have been experiencing greater correlation to stock movements which is likely due to the overall market’s sensitivity to stimulus actions


Hurricane Delta weakened into a category three storm just before hitting Gulf of Mexico earlier this week and is set to reach the Gulf Coast early tomorrow. The hurricane is predicted to strengthen again to category four, which may result in billions worth of damages depending on the actual path of the storm. 91.5% of oil production in the area has been shut in as of October 9th, which adds up to about 1.7 million barrels per day of US crude oil production. This should impact prices in the short-term, while the medium-term impact will depend on the severity of the actual damage of the storm (in the case of Hurricane Laura, prices retreated immediately on news that its storm surge was less than predicted). Damage, while temporary is likely to alleviate some of the downward pressure off of crude oil prices thanks to the production facility shutdowns, especially since Delta comes right on the heels of a recovering US Gulf from the effects of Hurricane Laura.

Hurricane Delta set to reach the shore of the US Gulf Coast on Friday evening in the US


A reversal in tone by US President Donald Trump on additional stimulus measures in the US may be indicative of a shift in approach to the Republicans' election strategy. Just hours after Trump said that he would halt negotiations with House Speaker Nancy Pelosi, he called on US lawmakers to pass standalone stimulus measures instead, one of which being US$1,200 in stimulus checks for Americans. Trump then proceeded to walk back on his stance even further on Thursday, calling on lawmakers to come together to agree on a comprehensive stimulus package. Politically, this may have been incentivised as a last-ditch effort to garner more support for votes for his campaign. We continue to expect a low probability of a large stimulus package being passed due to strong differences on details of the previous proposals set forth by both Republicans and Democrats. Most importantly, even if the White House and Democrats do agree on a stimulus package, more delays may still be expected since Republican Senators are still likely to scrutinise the bill before passing it through. This would mean that additional stimulus is more likely to come after the November elections rather than before and hence impact investor sentiment on the global economic recovery in the medium-term.

While we saw crude oil stockpiles in the US spike up last week, details of the report showed both gasoline and distillate inventories declining. However, a closer look shows us that total global implied demand for US crude oil (as calculated from changes in US distillate stockpiles and production) dipped the past two weeks and its three-month and six-month moving average still remains well below its five-year average. Likewise, implied demand for gasoline also remains below its five-year average. While the initial rebound in gasoline was strong, it appears to be flattening out likely thanks to the change in season and easing of pent-up demand for travel due to the prolonged lockdown period.

Implied demand for US distillate and gasoline still remains under pressure


On the coronavirus front, the EU will likely play a part in weakening oil prices in the short-to-medium term. While lockdown restrictions in multiple EU member countries has likely been somewhat priced into the market, there may still be room for downside in crude oil prices as the market continue to factor in a potential loss of demand and slowdown in economic activity in the EMEA area. While it shouldn't be expected that lockdowns will be to the extent of that in March to June, renewed restrictions will still put pressure on mobility and increase uncertainty to inflict a lower propensity of consumer spending.

Multiple large economies in the EU continue to face accelerating daily cases of Covid-19


Hence, we see some slight upside for WTI crude oil prices in the immediate term, possibly closer towards the 42.50's level, due to the impact of Hurricane Delta. Downside risks in the medium-term remain more prominent however, leading us to believe that upside in crude oil futures is more likely to be limited. As a result, WTI crude oil futures may face additional pressure back lower towards 38.77's level. Important to note that volatility remains high, especially with the US elections starting to intensify and markets becoming more sensitive to political news. In the longer-term, out view on crude oil recovery remains mostly in line with before, i.e. a slow and gradual one in line with the global economy while markets wait on a successful vaccine for the novel coronavirus. But again, with global policies shifting towards clean energy and prioritising environmental issues, longer-term investors may want to consider diversifying into either clean energy or oil producers that have initiated an accelerated shift into the renewable energy segment.

Technical Analysis:


Crude oil suffered a sharp correction early in September, but has since recover more than half of its losses. While recent developments have given oil prices a boost, it may only be short-lived. MACD is in a bullish cycle, signalling there may be some slight upside in the short-term. This coincides with our fundamental analysis, with the risk of damages to oil production facilities in the US Gulf Coast and the current political backdrop to be the biggest catalyst to oil prices in the short-term. However, RSI is trading in the upper region of its range, signalling that there could be some downside in the medium-term. While we do see oil prices dipping back lower towards 38.77, prices lower than that may be signs of overselling, in which traders may enter into bullish positions for some short-term gains.

Support: 38.77 / 37.08 / 34.67

Resistance: 41.47 / 42.50 / 44.19

USOIL Chart (H4)