Why Oil Traders Need To Be Extremely Cautious

Blue barrels of oil stacked sideways on top of each other
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Oil prices have been showing weakness for the past few weeks, raising the question of where we are headed from here. Traders may be wondering if the path of least resistance is going to be skewed to the downside for the rest of the year, or if OPEC+ will playing an active role in managing demand and supply in the market. Here are some of the factors to which traders need to pay attention that are behind the current price move.

Oil prices

Oil prices started the year near the $80, and so far this year the price has failed to reach the high of $131 achieved in March of last year. The reason for the price reaching that high level was due to a number of factors, like the war between Ukraine and Russia, OPEC+ showing no mercy in cutting supply, and of course, the post-COVID effect. During COVID, oil price futures went into negative territory for the first time in history as the whole world came to a standstill. OPEC+ did learn a costly lesson and has since made the world aware that it would not allow another rout in prices, no matter what happens. OPEC has announced a number of supply cuts since COVID, and it has been increasing supply cautiously, while the U.S. has been pressuring OPEC to increase its oil supply more proactively.

Saudi Arabia, which plays an active and major role in the OPEC+ cartel, paid no attention to the Biden administration’s request to not implement oil cuts. President Biden wants to keep oil prices low as higher oil prices fuel inflation, which is a major headwind for global economic growth. In October last year, OPEC+ announced a 2 million barrels per day production cut, and after that, it also announced in April this year another production cut of 1.5 million barrels per day. On both occasions, Saudi Arabia received a less favorable reaction from the U.S.

Why has the price moved lower?

This month, the price has reached a low of $63.75, as per the data chart below by AvaTrade. There are a number of factors that have been driving oil prices lower:

First, the whole world is fighting inflation. Central banks around the globe, especially in Europe, the U.S., Australia, and New Zealand have been playing an active role in controlling inflation. The option that they have been using is tightening monetary policy and rising interest rates. These banks have been increasing their base interest rates in order to tame inflation. The side effect of this is that it slows economic growth, and slower economic growth dampens demand for oil. Lower demand means oil prices have limited upside and are more than likely to move to the downside. This particular factor has been pushing oil prices lower.

Second, there was a lot of optimism among Wall Street banks who thought that reviving Chinese demand would support oil prices massively. The narrative was that China, a major consumer of oil, is coming out of COVID lockdown, and as businesses open up their operations, massive tailwinds would increase oil prices and reduce the need for a supply cut. In fact, some analysts and pundits were even speculating that OPEC would have to increase its production as more demand comes online.

The most recent factor that has created further headwinds for oil prices is the drama around the U.S. debt ceiling. Lawmakers do typically clinch a deal at the last minute (as looks to be the case right now), but until then, it creates unnecessary drama and pessimism among investors and traders, which adversely impacts oil prices. The U.S. defaulting on its debt obligations due to the failure to reach a debt ceiling deal is an event that many hedge funds have not priced. In short, this event is keeping pressure on oil prices.

OPEC's Sensitivity Levels

From the data chart provided by AvaTrade, the price level that traders need to keep an eye on is $65. Basically, anything below $65 is a level that is highly likely to bring comments and perhaps a reaction from OPEC+ members as they have vowed for price stability. This week, as the price dropped below the price handle of $65, we heard from the Saudi Oil Minister that speculators should trade their oil positions very carefully. The message that the Saudi Oil Minister wants to give is the same as before, which is that if oil prices continue to slide, they have an easy way to restore prices to a level where they feel comfortable—all they have to do is squeeze the supply tap so there is less output.

The level that I believe makes Saudi Arabia comfortable is anything that is close to $80; we seen reactions from Saudi Arabia and other OPEC+ members when the price begins to drop further away from this point.

Crude Oil: Technical Levels That Need Attention

From a trading point of view, the price of crude oil has been trading very much in a range-based manner. The crude oil chart below by AvaTrade shows two important things for traders. Firstly, the Relative Strength Index has provided a very ideal buying opportunity to oil traders for the past two times when it dropped below the level of 30 (shown in green circles on the chart). Secondly, the RSI’s overbought level (shown in the red circle) has also shown a great opportunity for traders to short. Traders go long (buy) when the RSI drops below 30, and they go short (sell) when the RSI reaches a reading of 70.

The two levels that are likely to create a reaction from OPEC+ are marked by arrows. The green arrow shows the price point at which, if crude oil prices visit this again or fall below that, there will likely be a reaction from OPEC+ members to restore the price. The red arrow is where things will become more favorable, and at that point we may hear some discussion about a potential supply increase, but it is unlikely that we will see any actual action as Saudis are still comfortable with this price.

Oil price chart

Final Thoughts

Traders and speculators must pay more attention to their trading strategies when they look at oil prices, which are currently adversely influenced by the economic downturn, soaring inflation, and U.S. debt ceiling issues. The Fed in the U.S. is under pressure to tame inflation, and it is likely that they will increase interest rates next month as well. If they do, that will only create more headwinds for the biggest economy in the world. This means that oil prices may begin to show another bearish move, but could potentially create a knee-jerk reaction from OPEC+.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Naeem Aslam

I am a former Hedge Fund Trader with over 15 years of experience in investment banking. During my early career, I was awarded a national award (Young Irish Broker) in 2010. Over the years, I have worked with Bank of America in equity trading and with Bank of New York in hedge fund trading. I specialize in Blockchain technologies (cryptocurrencies and digital assets) and Sustainable Investments. In my career thus far, I have also extensively covered Equities, Commodities and Forex.

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