A Closer Look At the Oil Market

From the WSJ:

Over the next few years, supplies are likely to be tight and demand is expected to keep rising. A security scare, cutoff in supply or shift in sentiment could send prices soaring again. But traders have begun taking into account other factors that could complicate the near-term outlook.

The International Energy Agency, the industrialized world's energy watchdog, said yesterday it was lowering its prediction for global demand growth for the fourth quarter, easing fears of a short-term supply crunch. Meanwhile, some officials at the Organization of Petroleum Exporting Countries have said it may consider raising its production ceiling next month.

Wall Street's speculators, who contributed to oil's 49% rise since the beginning of the year, have shifted direction this week. Yesterday marked the expiration of a key deadline in the crude-oil options markets. As it became clear that oil wouldn't hit $100 a barrel by the deadline, a chain reaction of selling ensued as traders unwound bets pegged to the risk of $100 oil.

In Riyadh, the de facto leader of OPEC, Saudi Arabian oil minister Ali Naimi, argued strenuously against "the pessimists," who he said have driven up prices by predicting supply shortages as demand in emerging markets soars.

Repeating a frequent lament of oil-industry officials, Mr. Naimi told reporters, "The price today has really no reflection whatsoever with the fundamentals" of supply and demand.

First, this analysis seems somewhat contradictory. The first paragraph contains a tacit admission of tight supplies and geo-political risk. However, the Saudi oil minister then states prices don't reflect the fundamentals. Frankly, the fundamentals to me look incredibly bullish. While I am sure there is understandable disagreement about the degree of the market tightness and political risk, the overall outlook for the energy sector still looks like a bull market to me -- especially with 2 billion more Indian and Chinese consumers coming online in a their respective growing economies.

That being said, let's look at the chart.



Yesterday, oil broke a short-term uptrend that started in early October. However, notice there are four technical areas of support along with the 50 day SMA. In other words, there are plenty of places for prices to consolidate without having the market turn into a bear market.

For the rally to continue, it is crucial for oil to maintain the second uptrend that started in late August. Eyeballing the chart, that looks to be about 86 or so.

In other words, before we start popping the champaign corks, let's wait and see what the market does over the next week or so.