Has oil bottomed? Markets are starting to bet that it has

Is the bear market in oil over?

It’s starting to look that way, after another big move up in crude prices overnight, adding to the 7% gain it posted on Friday.

Prices have swung sharply within a $3/barrel range so far Monday, as short-term trading instincts clash with long-term fundamentals.

Over the last month, traders who started the year by ‘shorting’ oil had made a tidy profit, as the price had fallen from $53.27 a barrel to as low as $44 by Friday. With the end of the month coming, and with the downward momentum have having eased over the past weeks, it seemed sensible to close “short” positions and take a fresh view on the market for February.

When everybody in the market is short, prices can snap back pretty sharply, especially when key technical indicators which are followed by short-term traders start flashing green.

Reuters reported that the trigger in this case was the fact that the front-month contract price closed above the 20-day moving average for the first time since July.

The trouble is, the fundamental balance between supply and demand hasn’t really changed that much yet. The world is still producing more oil than it needs. Most people still don’t expect prices to bottom until the second quarter at the earliest.

What made some change their minds about that was data from oilfield services firm Baker Hughes on Friday, showing that the rig count in the U.S. and Canada–a good indicator of future production trends–had fallen by 128 in a week to 1,937. That’s down by nearly a quarter from last year’s peak and evidence that lower prices are starting to deter spending on new output. The falling rig count is consistent with a string of large-scale cutbacks in investment spending by both majors and independent producers in recent weeks.

Baker Hughes' rig count put the defibrillators on the oil market Friday...
Baker Hughes’ rig count put the defibrillators on the oil market Friday…

In addition, U.S. gasoline consumption has picked up in recent weeks, suggesting that demand is also responding to lower prices.

But outside North America, not much has changed yet. The Organization of Petroleum Exporting Countries actually raised its output in January by an average of around 160,000 barrels a day, according to a Reuters poll, as countries like Saudi Arabia and Kuwait continued to defend their market share.

...but the patient's not out of the operating room yet.
…but the patient’s not out of the operating room yet.

In its latest report on the oil market, OPEC still said it expects supply to grow by an average of 1.28 million b/d this year, while demand will only grow 1.15 million b/d.

Making things slightly more complicated Monday is the strike by the United Steelworkers union at refineries that produce one-tenth of the country’s gasoline.

In theory, that ought to depress crude prices, because it means less crude is being taken out of inventories that are already at record highs, so today’s crude output has even fewer buyers. However, it’s unclear just how much disruption the strike is causing, as many refinery operators have contingency plans to carry on working without unionized labor.

By 0915 ET, the front-month contract for the West Texas Intermediate blend was at $49.53 a barrel, up $1.30 or 2.7%.


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