Crude Oil Prices are Oversold and Should Rebound

Oil prices have been hammered as the coronavirus that has spread throughout China. The theory is that this epidemic could reduce global transportation fuel needs. On Tuesday the US announced that airlines could cancel trips to China at their discretion. The demand issues are probably priced into WTI, along with the huge increase in oil production investors have seen in the United States during the past 12-months. While OPEC is likely to reduce or maintain future output it will be US output that will drive future prices. With WTI prices in oversold territory, traders could expect a bounce in crude oil prices.

Production

US production has created a balance in the crude oil markets. Prior to the huge run-up in US production, any supply outage would drive prices much higher. The current production and demand balance has provided a cushion that keeps prices moderate if there is an outage or skirmish which was seen when the US and Iran attacked one another.

During the past year, the US has increased crude oil production by more than 1-million barrels per day. According to the most recent report from the US Department of Energy, US daily oil production is currently 13-million barrels a day up from 11.9 million barrels per day at the same time one year ago. The question for traders is whether the US will be able to keep up this pace.

Rigs Counts are Down but Moderating

The rigs count in the US has been falling but recently has ticked higher. According to oil service giant Baker Hughs, the oil rig count was 676 versus 673 in the week ended January 17. Thus, despite a reduce capital spending budget for 2020 due to lower prices, drillers added rigs in the domestic plays. The current total rig count is down 186 rigs during the past year from 862 and is well of the highs which were 1,609.

With demand slipping there is likely to be some adjustment to production. The EIA in its January 2020 short term energy forecast expects production will increase 9% in 2020 from 2019, but this is down from its last estimate which was 11%. The EIA also expects the US rig count to continue to decline during 2020 which should weigh on production.

Technicals

Oil prices are oversold, and beginning to rebound from the recent drop. The sharp decline in prices put the relative strength index (RSI) below the oversold trigger level of 30. Recall, levels below 30 are considered oversold on the RSI while levels over 70 are considered overbought. The movement from oversold to the neutral range (the RSI is moving higher) is a sign of a potential rebound that could foreshadow a correction.

Additionally, the fast stochastic has generated a crossover buy signal in oversold territory. The current reading on the RSI is 15, below the oversold trigger level of 20 which could also foreshadow a correction.

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Oil prices have tumbled and provided good risk-reward. The stop-out level on a purchase of crude oil could be below $51, as traders look for a rebound in the price of WTI crude oil back to the 200-day moving average near $57.50. The risk-reward is good for a short-term trade and without the scare that the Chinese coronavirus is creating prices would likely be closer to the 200-day moving average. The technicals point to a rebound and declining rig counts should benefit the supply and demand balance.