Monday, August 15

Will oil break its high prices?

An article by Ramón Morell, market analyst at Skilling ● Since 1854, when Pennsylvania Rock Oil Company drilled the first oil extraction well, oil has become the most important raw material in the industrial world.

Not only as a source of power generation, but also as an essential element of many industrial products, such as plastics, clothing, detergents, even ink.

The Brent price it topped $ 175 a barrel in 2008 and has since hovered between $ 25 and $ 65 with a brief push to $ 85 in October 2018. And here we are again… and rising.

Offer and demand

The laws of supply and demand dictate that the final price will tend to break even at the highest price that buyers are willing to pay and the lowest price that sellers accept for their product.

If demand increases over time, prices will rise because more buyers will compete for the same volume of product. And on the other hand, a growing supply will lower prices as producers compete with each other to sell their product.

In the case of oil, its demand is made up of billions of final buyers, channeled through companies and governments around the world. Instead, the supply comes from a limited number of producers, countries with crude oil reserves that are being extracted by their governments or indirectly through agreements with private companies.

Traditionally, suppliers could control production to raise prices or keep them above a certain level. This is the reason for the creation of OPEC in 1960.

But there are other actors on the supply side whose production is also considerable, such as the US and Russia.

OPEC is generating more than 50 percent of global crude production and controls 90 percent of world reserves, while the US is the largest producer and at the same time the largest consumer. Therefore, its role has been progressively relevant today. And the elasticity of global supply as well.

Supply and demand have been oscillating, mainly due to the evolution of the demand side and particularly due to the damage caused by the pandemic crisis.

At this time, consumption is recovering and demand is pressing above current production and therefore the constant increase in price that we are experiencing.

What is the forecast for the next few months?

Most of the analysts consulted agree that there will be a continuation of the upward trend in prices during the fourth quarter, simply because global demand appears to be increasing despite some potential threats to world economies.

And production is also growing, but not at the same rate as demand.

However, it is generally assumed that production will accelerate during the first half of 2022, while demand could lose some momentum once financial stimulus from central banks comes to an end.

In fact, the EIA in its short-term outlook report on energy, published on October 13, estimates that Brent prices will decline during 2022 to an annual average of $ 72 per barrel.

This also depends on the main alternative sources of power generation, such as coal and natural gas, and their availability and cost.

We have observed a shift from natural gas to the consumption of petroleum derivatives in those industries whose structures allow them to combine the use of both sources.

Finally, an additional issue to include in this kettle is the impact of those factories that are about to make the decision to limit or totally stop their production at current energy price levels, given the difficulty of transferring these costs directly to the final consumer.

A technical approach to the evolution of the price of oil?

Technically there is a strong uptrend when we look at Brent on a daily candlestick chart, since the beginning of September, targeting $ 90 and with enough momentum to hit $ 100 or more before the end of the year.

But taking a more global view of price action on a monthly candlestick chart, we are shown another scenario. With key resistance around current prices and well below the levels we had about eight years ago.

All resistance can be broken, as we have seen frequently in trading, it is a matter of there being enough upward pressure from a combination of a constant recovery in the economy and a production industry that cannot keep up.

Or producers might resist the temptation to produce more if prices are such that they can finance their budgets without having to increase extraction.

But WTI crude is doing something different. Although they are highly correlated, they also have their own elasticity of supply and demand. WTI prices have passed the 2008 benchmark and there is technically no resistance until the $ 100 mark.

In my opinion, these small divergences are not going to push Brent and WTI prices out of their step-by-step advance towards the magic $ 100 figure. Sure, looking at a 15-minute candlestick chart, there are corrections and interesting short position opportunities.

Swing trading works even in small timeframes. But the global scenario calls for higher heat intensity below these energy products, at least until the end of the year and towards the $ 100 mark.