The surprise OPEC+ production cuts last week had investors frantically positioning themselves in anticipation of the opportunities, risks, and opportunity risks surrounding crude oil exposure.
What Just Happened?
On Monday, OPEC+ announced it was reducing its output by 1.16 million barrels per day. The cuts are to begin in May and will continue until the end of the year.
Why's This a Big Deal?
The global economy runs on oil. As a major global input, it will affect not only the cost of production, but consumer costs as well. Even if a product isn't made using petroleum, its means of transportation and delivery are likely powered by petroleum. So, in a way, oil powers almost everything you buy.
Making Matters Worse...
Given Russia's invasion of Ukraine, this move has shaken up the global energy markets and further exacerbated the tense geopolitical landscape.
Remember OPEC's earlier reduction of two million barrels back in October? Well, that increased tensions between the US and its long-time ally, Saudi Arabia. Currently, the nation is seeking entry into BRICS, which can reduce demand for petrodollars (another huge matter altogether that we won't discuss here).
What Are Analysts Predicting?
Several analysts say that the cuts may push crude oil prices back up to $100 per barrel (or higher). CMC Markets' analyst Tina Teng told CNBC that oil prices might move toward the $100 mark, considering China's reopening and Russia's output cuts. A Reuters® report also supported the possibility of oil prices moving toward $100 a barrel.
What Are Investors Thinking?
They're probably tempted to jump into a trade and readjust their portfolio for heavier crude oil exposure. Is it a wise thing to do? After all, Saudi Arabia's cuts aim to counter the global decrease in industrial output, so it says. Its move aims to stabilize the oil market.
Fundamentally, it may be wise to go long oil, especially considering how this "stabilizing" action may also be a form of geopolitical posturing in support of BRICS and defiance of the West.
Headwinds and Turbulence Ahead
Let's use the United States Oil ETF (USO) as a proxy for WTI crude oil. The fundamental driver may be enough to fuel oil's trajectory toward $100 a barrel. But it's likely to be a turbulent flight, considering the resistance levels ahead (see chart below).
CHART 1: WHICH WAY FOR OIL? USO broke down from a rectangle formation. A breakaway gap took prices just below the resistance within the rectangle. A divergence between price and the Chaikin Money Flow indicate the possibility of increased buying pressure.Chart source: StockChartsACP. For illustrative purposes only.
- In March, oil broke down from a three-month rectangle formation. Typically, this is a continuation pattern that hints former support will turn resistance. But then, OPEC+ came along with an unpleasant surprise.
- A breakaway gap occurred over the weekend, falling short of resistance within the rectangle (see the blue-dashed line). In general, gaps are likely to be filled or tested. To demonstrate convincing momentum for USO's upward movement based on the fundamental principle, let's anticipate that it won't drop below the rectangle formation's low point (support) and will instead break through the formation itself.
- Note the divergence in the Chaikin Money Flow in relation to USO's low, as it broke below the bottom of the rectangle formation. This indicates the possibility of increased buying pressure while USO's price was sinking.
- The main feature here is the multiple resistance levels facing USO on its way up toward analysts' $100 price target.
The Bottom Line
Why make such a big deal out of this? It's only a big deal if you're not expecting it. Investors relatively new to (or unfamiliar with) basic technical analysis should know what to expect.
It's like a turbulent flight. You have conviction that you're getting from point A to point B, but the bumpiness can easily shake your resolve. But while flight passengers have no choice but to power through the ride, investors can easily exit.
And while no expert can predict whether oil (or, in this case, USO) will ever reach analysts' fundamentally-driven price target, using these charts can at least help you map out the course and prepare for several technical headwinds ahead. This, in turn, can give you more options to manage or adjust your trade, rather than simply bailing out.
Disclaimer: This blog is for educational purposes only and should not be construed as financial advice. The ideas and strategies should never be used without first assessing your own personal and financial situation, or without consulting a financial professional.
Happy charting!
