The important question on crude oil is what is really affecting prices at this moment? The answer is oil inventories. There is near term headwinds for oil prices created by storage overhang and gasoline glut in the US. Crude inventories in US are at a historically high 519.5 million barrels for this time of year according to the EIA (The Energy Information Administration). This summer season also peak demand failed to draw down inventories. Another factor that is working against crude oil was the recent currency movements. European Central Bank (ECB) indicated that it would hold off on deeper stimulus pushing US dollar up and since oil is priced in US dollar, strong dollar pushes crude prices down. Japan will decide next week about its monetary policy and that may also create currency movements in the market.
On the other side of the world, China is also dealing with too much gasoline supply. China is continuously increasing production and in June the production was at record high. Its exports have also doubled from year earlier. After US, China is an important market for Crude oil. Supply is outstripping demand and China along with South Korea and Japan are flooding the market with gasoline exports. According to data released by Baker Hughes, the number of active U.S. oil drilling rigs rose once again last week. Increase in rig count suggests that companies are resuming new well drilling which will increase production level. According to CFTC (US Commodity Future Trading Commission), Hedge funds net-long position in WTI fell by 23,665 futures and options combined to 156,804 and shorts surged by 24 percent. This indicates market participants are bearish in crude.
The only consolation for crude oil is Saudi Arabia’s depleting crude inventories. According to The Wall Street Journal from October 2015 to May 2016, Saudi crude inventories dropped 12 percent to 289 million barrels, the longest period of decline in 15 years. However the drop in inventories can be explained easily as the domestic demand of Saudi Arabia is strong because of summer. Also Saudi Arabia is not increasing production as that would spook the market indicating they are flooding the market, so the best way for them to cope with seasonal domestic demand is by using their inventories. Second point is that maintenance season is coming. As summer comes to an end and refiners turn to maintenance which will decrease some of the inventory. But the peak seasonal demand for Crude oil is diminishing and inventories are increasing a negative combination for crude oil prices.
In MCX, crude oil has made rounding top which indicates top has been made and the commodity is expected to correct. We anticipated crude oil to correct till Rs 2,750/barrell and it made low of Rs 2,730 on July 30. It also failed to take support at its 200 day moving average. On the higher side, Crude Oil failed to break the resistance of Rs 3,450, where in month of May and June, it made multiple highs of Rs 3,442, Rs 3,439 and Rs 3,425. Each time it corrected from the high by around 8-10 percent. Crude Oil is expected to correct further till Rs 2,550-2,450. Any fresh long position can be created around that level. However those investors who are in short, we recommend to take profit in staggered manner as crude oil has fair bit of support around Rs 2,400 levels. Long term, crude oil still is weak and as long as demand supply disparity is there, we expect crude to remain under pressure.
(The author is Director, Tradebulls)