A lightning fast rally in oil prices is reversing. Here’s why

A downbeat outlook for oil demand from a top energy watchdog and fears of rising U.S. output sparked a sell-off in crude futures this week, but analysts say the market was already poised for a pullback.

International benchmark Brent and U.S. West Texas Intermediate crude have both shed about $3 a barrel, or nearly 5 percent, from more than two-year highs struck last week.

Brent was trading at $61.63 on Wednesday, while WTI was at $55.15, both down about 1 percent after posting their worst daily performance in about a month on Tuesday.

It is a pullback from a recent spike fueled by signs of improving oil demand and a month of escalating tensions in the Middle East that threatened output from top OPEC producers.

But on Tuesday, the International Energy Agency lowered its outlook for demand growth in both 2017 and 2018, in part because of warmer than expected winter weather. The energy policy adviser to developed nations knocked down its growth forecast by 100,000 barrels a day for each year, projecting that oil markets will remain oversupplied in the first half of 2018.

Global demand will struggle to sop up rising output by producers outside the 14-member OPEC cartel, particularly from the United States, IEA said in its monthly oil report. Recent weekly figures show U.S. drillers are pumping near all-time high levels.

“This is why, absent any geopolitical premium, we may not have seen a ‘new normal’ for oil prices,” IEA concluded.

That view contradicted OPEC’s projection, which had been released one day earlier. The producer group raised its forecast for demand growth by 130,000 barrels a day in 2018.

Adding to the commotion, oil futures got caught in a general commodities sell-off following weaker-than-expected economic data from China, which drives global commodity consumption.

Oil prices rose last week on concerns about rising tension between regional powers Iran and Saudi Arabia, as well as uncertainty stirred by a sweeping political purge orchestrated by the powerful Saudi crown prince.

But as of this week, the anticipated abdication of the Saudi king and the rise of Crown Prince Mohammed bin Salman appears to be on pause.

“All that got fed into prices last week and nothing is happening,” said John Kilduff, founding partner at energy hedge fund Again Capital. “The risk premium gods giveth and they taketh away,” he told CNBC.

The rally in U.S. crude futures stalled just short of $58 a barrel last Wednesday, Kilduff noted. That day, WTI posted a higher high and a lower low than during the previous session and ultimately closed lower, setting up a key reversal signal, he said.

The number of long positions, or bets that oil prices will continue to rise, suggested that the rally didn’t have much more room to run, analysts warned CNBC earlier this month. Hedge funds have raised their bullish bets on U.S. crude to the highest level since March, while bearish positions fell to a nearly seven-month low.

Analysts say traders who went long on oil at the tail end of the rally likely closed those positions as prices plunged on Tuesday, sparking a sell-off that caused longer-term buyers to also join the selling frenzy.

“If pressure comes in to continue the sell-off, then those who have been riding it for some time will start to flatten out their positions, as well,” said Andy Lipow, president of Lipow Oil Associates.

“We had a fairly significant run-up, so the market’s taking a pause and we’ll continue to see whether global inventories continue to draw,” he added.

The market will also be watching developments in Venezuela, where embattled President Nicolas Maduro is finally attempting to restructure the nation’s debt amid a full-scale economic crisis. The Latin American nation contributes about 2 million barrels a day to the global oil market, though its output has been slipping as it struggles under the weight of U.S. sanctions and deteriorating credit.

“If it really moved into turmoil and you lost oil from Venezuela, that would be a shock to the market. This is like the slow-moving collapse that’s happening,” Daniel Yergin, vice chairman of IHS Markit told CNBC on the sidelines of the Abu Dhabi International Petroleum Exhibition and Conference on Wednesday.
Source: CNBC