Even though Saudi Arabia was quick to proclaim a victory at the outset of the year after reducing its own oil production to levels agreed upon in Vienna, there are numerous threats to the outlook for crude prices. Despite claims that the move to reduce OPEC output will be enough to drain the approximate 300 million barrels in global oversupply within six months, a move by the Cartel and non-OPEC members to ramp up production afterwards could beckon the resurgence of global oversupply.

Besides the focus on OPEC, ex-OPEC production is on the climb, driven in large part by efforts to restart shuttered US shale production. With many projects now breaking even or modestly profitable at current oil prices, the revival of American productions stands as a significant threat that could offset the gains following the output freeze. Now that many of the formerly indebted companies declared bankruptcy and have now cleaned up their balance sheets, several of these projects operate on razor-thin margins, adding significant production capacity that could readily overwhelm all the OPEC gains.

Famous Last Words from Saudi Arabia

In a surprising development on Monday, Saudi Energy Minister Khalid Al-Falih sent oil prices tumbling following remarks that implied the Saudis were not expecting to maintain production cuts after six months. Although he reiterated Saudi Arabia’s commitment to observing the terms of the deal, Al Falih’s assurances were not enough to assuage markets that see the potential for the glut to reemerge during the second half of the year if cuts are not maintained. Originally, when the deal was agreed upon in November, OPEC determined that the cuts could be extended after six months depending on market conditions. However, Saudi comments seem to suggest that they are unwilling to go any further than the 6 months promised.

Al-Falih’s comments were predicated on the 1.800 million barrel per day decline in output agreed upon with 24 nations back in December. Based on these figures, the broad idea was to eliminate oversupply to the tune of an approximate 300 million barrels sitting in reserves, onshore storage, and offshore storage vessels. However, this would be contingent on OPEC members and other nations respecting their output agreements and not exceeding quotas. Furthermore, if global demand is unable to grow as forecast by OPEC, any move not to extend the deal framework could result in similar conditions that first brought oil price to multi-decade lows in 2016. However, besides the Saudis, the big looming problem is resurgent production from tight oil projects.

The United States should be a primary focus for oncoming production considering the country’s producers were not a party to the OPEC and non-OPEC deal and could readily upset the delicate balance that OPEC has most recently achieved. The number of operational oil rigs continues to climb despite a minor setback last week which showed a decline of 7 oil rigs to 522 active rigs after 11-straight weeks of increases. However, the material development that should not be ignored was the surge in US production, which climbed by 175,000 barrels per day in the span of the last week of December and the first week of January. Should production continue to climb, OPEC’s cuts could prove negligible, sinking oil prices once more.

Technically Speaking

Since reaching the most recent multi-year highs at the outset of 2017, oil prices have come under renewed pressure, with the last move higher looked upon as slightly overbought according to certain momentum indicators. The Stochastic Oscillator, for instance, implies that the after being modestly overbought at the end of 2016, prices have since been pulling back, bringing the oscillator as low as oversold territory earlier in the month of January. Although the crude oil trend on a medium-term basis has been largely positive, with prices trending within a bullish equidistant channel formation, the bounce from the upper channel line implies an ongoing correction in prices.

Standing in the way of any deep pullback in prices are both the 50 and 200-day moving averages. Although the 50-day moving average is unlikely to hold up as a significant support level, the 200-day moving average neatly coincides with the lower line of the equidistant channel. Any fall through this point could be viewed a channel-based breakout. If confirmed by a candlestick close below the lower channel line accompanied by heightened volume and downward momentum, crude oil prices could find themselves testing the mid-$40s per barrel over the near-term. On the upside, however, WTI faces resistance near $56.00 per barrel. However, any rise to this level would be reliant on more focused, long-term efforts to kill prevailing market oversupply.

Looking Ahead

Based on the abundance of risk factors threatening the most recent gains in oil prices, it is hard to foresee a situation in which the upside risks outweigh the potential downside. Despite OPEC taking real and serious steps to reduce the glut and end oversupply, as Saudi Arabia has shown, the deal will be given six months and is not considered a longer-term solution. Further threatening the deal is resurgent output from other key regions such as the United States. If production continues to climb on the back of higher prices, the fragile market equilibrium that was reached in the post-Vienna deal could fade rapidly. With all the factors that could go wrong relative to what could be positive, it will be difficult to remain bullish through the end of the first half of 2017.

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