U.S. West Texas Intermediate and international-benchmark Brent crude oil futures are trading higher on Tuesday after failing to follow-through to the downside the previous session, following Friday’ steep sell-off. The price action suggests traders may feel the sharp break may have been overdone.
Traders also seem to be shrugging off concerns over rising output from the United States and OPEC and its allies, which would offset most of the shortfall expected from the expanded U.S. sanctions against Iran. This is just speculation, however, since supply continues to remain tight.
The tight supply situation could also be the reason bearish traders failed to blink after China reported weaker-than-expected manufacturing and servicing data for April earlier in the session. This news indicated that China’s economy was still trying to gain traction in response to government stimulus and optimism over a U.S. – China trade deal.
The big issue for traders remains whether Saudi Arabia and its allies will be willing to meet the shortfall from the new sanctions. And the answer is probably yes, but not because of President Trump’s pressure on OPEC and its de-facto leader Saudi Arabia, but because a surge in prices would be bad for business.
Saudi Arabia and its allies don’t want prices to surge so high that it affects demand, especially given the global economic weakness.
As Stephen Innes, head of trading at SPI Asset Management, puts it, OPEC “will want to avoid at all cost oil prices surging to levels that will trigger demand devastation, (while) it is clearly in OPEC’s best interest to maintain a solid floor on prices.”
Over the short-run, we expect to see a choppy, two-sided trade as speculators continue to try to determine how much Iranian oil production will decline once the new sanctions take effect. Initially, traders thought 1 million barrels per day would be lost. Later, this figure dropped to 600,000 bpd.
On Monday, Bank of America Merrill Lynch said, “Iranian oil production will fall to 1.9 million bpd in 2H19 from 3.6 million bpd in 3Q18 as U.S. sanctions kick in and waivers eventually expire.”
As long as WTI and Brent Crude oil remain over the 200-day moving average, the professional hedge and commodity funds will remain long. We’re likely to see a test of last week’s highs and prices could continue to move higher, but eventually the rally will stall due to a sharp rise in U.S. exports.