Is Oil’s Comeback Temporary?

The price of oil sits comfortably around $40, being bid on every single dip lower. The end of last week brought a decline of more than 5% in one single day, bringing fears of the oil participating in a risk-off market move. However as it turned out, it was just another opportunity for bulls to step in – this week on Monday the oil rallied almost ten percent, knocking at the $40 level again.

The $40 level held resistance for more than three months now. It has a special significance for the oil market. Back in 2018, oil fell from $78 in an almost straight line. In doing so, it reached $40 and bounced strongly.

It was not until one-and-a-half years later that oil broke support at the $40. Hence, we should not be surprised at all that the $40 level acts as strong resistance on any attempt higher.

Can it move higher? Most likely.

A Bullish Thesis for the Price of Oil

Oil reacted in an unprecedented manner to the coronavirus pandemic generating economic lockdowns in the developed world. More precisely, as Europe and some North American states began shutting down, the price of oil broke the $40 level.

In April, it did not stop all the way to negative $40. As it happened, there were simply no buyers for the futures contract that expired in May. Because the clearinghouse let negative prices happen, the price of oil settled right there – a historic -$40.

Supply and demand play a crucial role in the price of oil. That is the moment when OPEC and some other oil-producing countries intervened and cut the production levels. To do so, one needs time as cutting down production does not work by simply turning an oil well on and off. But the cut did the trick.

Fast forward six months, and the oil market looks different. In fact, it looks like the market is undersupplied, heading into the end of the year’s trading.

The price of oil recovered to the $40 on the back of economies reopening. Inventories fell, the market stabilized, and the economic recovery, as shown by the PMIs, is picking up all over the world. However, production levels remain the same, with OPEC leaving them more or less at similar levels as the ones in May and June.

With the U.S. shale oil industry still suffering from the low prices we have seen in the last months, the price of oil has a chance of breaking the $40 level. From a technical analysis perspective, the move from -$40 to the current $40 looks like a pennant formation. If that is correct, its measured move points to levels above $80.

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