Over the past week and a half, crude oil prices have been on a rollercoaster ride. Within the large ranges, the force of gravity has generally worked against bullish speculators after the three-week rally ended in mid-August when Brent hit $51 per barrel and U.S. West Texas Intermediate (WTI) reached $49 a barrel again. The two oil contracts now find themselves at $48.20 and $45.95 a barrel, respectively. Still, compared to the lows of around $41.50 a barrel and $39.50 a barrel at the start of the month, August has been a good month for both oil contracts – provided we don’t see a vicious sell-off later on in the session when the U.S. weekly oil report is published. To some degree, oil’s performance since the middle of the month can be explained away by the impact of the dollar, which has bounced back sharply during this period. As crude oil is denominated in the dollar, this makes it more expensive for holders of other currencies when the greenback appreciates. But the impact of the dollar on oil should be temporary, especially given that the price elasticity of demand for crude is considered relatively inelastic. Therefore, if the dollar were to appreciate significantly now as a result of further improvement in U.S. data and a resulting rate rise from the Fed, crude oil may not necessarily go in the opposite direction. After all, the potential improvement in U.S. economy would also imply stronger demand for oil.
When you ignore the short-term flections in oil prices due to the movements in the U.S. dollar, the fundamentals for crude oil from an actual supply and demand point of view becomes a lot clearer. On this front, little progress has been made however. Clearly, many speculators are now just waiting to find out whether Saudi Arabia and other members of the Organization of the Petroleum Exporting Countries (OPEC) will agree next month to a production freeze deal with some non-OPEC producers, led by Russia. Both Iran and Iraq have come out in recent days, stating that that they support the idea of an output freeze…as long as it doesn’t impact their own pursuit of market share! If these important OPEC members go into the meeting with that sort of mentality, I would be very surprised to see any sort of agreement being achieved. So the potential is there for a sharp drop in this scenario, but like the previous case earlier this year, the downside could well be limited due to on-going expectations that the market will tighten anyway as U.S. shale output declines further and demand rises.
But in the short-term outlook, oil is likely to find direction from the latest U.S. oil stockpiles report and as mentioned the direction of the U.S. dollar. Last night, the American Petroleum Institute (API) reported that U.S. oil inventories rose by a less-than-expected 942,000 barrels last week, while Cushing stocks declined by 620,000 barrels and gasoline by 1.6 million barrels. However, the report wasn’t considered bullish enough to support WTI oil prices, possibly because of the fact there was a huge build in stocks of distillates which rose by three million barrels. The official report from the U.S. Department of Energy Information Administration (EIA) is due out at 15:30 BST (10:30 ET). It will need to first and foremost confirm the declines in Cushing crude and gasoline stocks. If the report also shows that the overall build in U.S. oil stocks was less than that reported by the API, or better still, a drawdown then we could see oil prices bounce back.