Crude Oil Price Forecast: Breakout Above Yearly High Nears, But…

CRUDE OIL OUTLOOK:

• Energy markets have been on fire in September, and a push to fresh yearly highs may not be far away for crude oil prices.
• However, the recent shift to a positive correlation between crude oil prices and volatility may be a warning sign that a bout of weakness may arrive first.
• According to the IG Client Sentiment Index, crude oil prices have a mixed bias.

CRUDE OIL PRICES ON FIRE

Global supply chain concerns and growing demand for energy are having a positive impact on crude oil prices, which have climbed six of the past seven trading sessions and 12 of the 19 trading sessions thus far in September. Of note, the financial media has been reporting on UK fuel supply shortages and power outages across China, leading to increased volatility in energy markets.

In terms of increasing global oil production, news this week suggested that OPEC+ would be sticking to its earlier plan to add +400K barrels per day in November, below hopes of an increase to +600K bpd.

In terms of the US oil inventory data, the rise of +4.6M barrels beat expectations as Gulf of Mexico facilities came back online faster than expected following two hurricanes in recent weeks. Nevertheless, US oil output is only back to 11.1M barrels per day, still below the near 13M bpd pre-pandemic.

As noted previously, it is our base case scenario that the persistent supply-demand imbalance that has defined energy markets throughout 2021 will continue, which helps keep intact the bullish fundamental argument for the next few months. As a result, while a break to fresh yearly highs may be around the corner for crude oil prices, there is a near-term warning sign to be concerned about.

RELATIONSHIP BETWEEN OIL VOLATILITY AND OIL PRICES ISSUES WARNING SIGN

Crude oil prices have a relationship with volatility like most other asset classes, especially those that have real economic uses – other energy assets, soft and hard metals, for example. Similar to how bonds and stocks don’t like increased volatility – signaling greater uncertainty around cash flows, dividends, coupon payments, etc. – crude oil tends to suffer during periods of higher volatility.

OVX (OIL VOLATILITY) TECHNICAL ANALYSIS: DAILY PRICE CHART
(SEPTEMBER 2020 TO SEPTEMBER 2021) (CHART 1)

Oil volatility (as measured by the Cboe’s gold volatility ETF, OVX, which tracks the 1-month implied volatility of oil as derived from the USO option chain) was trading at 35.32 at the time this report was written. Oil volatility continues to persist around levels experienced going back to 2019, but the recent shift in the relationship towards a positive correlation hints at a near-term top.

The 5-day correlation between OVX and crude oil prices is +0.92 while the 20-day correlation is +0.12; and one week ago, on September 22, the 5-day correlation was -0.87 and the 20-day correlation was -0.56. In 2021, three of the past four times that the 5-day correlation between OVX and crude oil prices moved above +0.60, crude oil prices either traded sideways or experienced a pullback over the ensuing week.

CRUDE OIL PRICE TECHNICAL ANALYSIS: DAILY CHART
(SEPTEMBER 2020 TO SEPTEMBER 2021) (CHART 2)

Crude oil prices have marched higher over the past week, running up to the July (and yearly) high established at 76.98. The triangle in place from mid-May through early-September is nearing completion, suggesting that a pause may be due for some short-term profit taking before longer-term technical buyers step back into the fray. Yesterday’s doji candle may also mark the middle candle of an evening star candlestick pattern.

Otherwise, bullish momentum has firmed up suggesting that a pullback in crude oil prices could be short-lived. Crude oil prices are above their daily 5-, 8-, 13-, and 21-EMA envelope, which is in bullish sequential order. Daily MACD continues to extend its climb above its signal line, while daily Slow Stochastics are persisting in overbought territory – an indication that buying pressure remains strong.

CRUDE OIL PRICE TECHNICAL ANALYSIS: WEEKLY CHART
(JANUARY 2008 TO SEPTEMBER 2021) (CHART 3)

While the the November 2020 and May 2021 uptrend was breached, crude oil prices have traded sideways for several months. This consolidation is transpiring after breaking the downtrend from the July 2008 and July 2014 highs, suggesting that another upside move is due before the end of the year. As such, the longer-term technical posture remains bullish. A doubling of the multi-month sideways range (76.98-61.56) suggests a measured move up to 92.40, which puts crude oil prices on track to reach the OPEC+ fiscal breakeven of 92.00 before the end of the year.

IG CLIENT SENTIMENT INDEX: CRUDE OIL PRICE FORECAST
(SEPTEMBER 29, 2021) (CHART 4)

Oil - US Crude: Retail trader data shows 36.29% of traders are net-long with the ratio of traders short to long at 1.76 to 1. The number of traders net-long is 0.74% lower than yesterday and 23.44% lower from last week, while the number of traders net-short is 7.45% lower than yesterday and 21.48% higher from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests Oil - US Crude prices may continue to rise.

Positioning is less net-short than yesterday but more net-short from last week. The combination of current sentiment and recent changes gives us a further mixed Oil - US Crude trading bias.

Written by Christopher Vecchio, CFA, Senior Strategist