Crude Oil Correction Imminent

Oil prices fell sharply on Thursday after the US Department of Energy reported an unexpected rise in US crude stockpiles. Whereas oil analysts were looking for a sharp 4.4-million barrel drawdown in the headline figure after the American Petroleum Institute (API) had estimated a similar figure on Tuesday, the DOE actually reported a rise of 1.25 million barrels. Prices fell sharply when the news hit the wires, before staging a small recovery amid profit-taking. But prices have since weakened again and with Saudi and OPEC increasing oil production again, there is a real risk of a correction in crude prices.

Indeed, the near-term technical outlook on prices could turn bearish, possibly as early as today. If you recall from our last report on oil on Monday, we wrote that WTI could be heading to $75 due to momentum. That said, we also noted that we were “certainly not bullish oil prices at these levels.” We argued that while momentum could certainly help keep prices go a bit further higher (which turned out to be the case), the growing oil production in the US and the fact that Venezuelan oil production won’t remain low forever may eventually derail the rally. Specifically, we reported that only when there is technical evidence of a top in oil will we turn bearish on prices. And on that note, we may have seen a short-term top.

As per Monday’s report, we were waiting for WTI to break below support at $72.60 to tilt the bias in bears’ favour. It looks like a breakdown here is only a matter of time given crude’s unwillingness to push further higher after the recent breakout. If WTI does break decisively below $72.60, this could lead to further technical selling pressure, paving the way for a subsequent drop towards the bullish trend and support at around $69.35 next. However, if the buyers defend their ground here at $72.60 again then a return to $75.00 would not come as major surprise. In any case, we can’t see prices going significantly higher without a sizeable correction first.

In fact, the higher time frame weekly chart of WTI shows an even scarier picture for it has turned lower from a long-term broken support level i.e. $75 and is in the process of forming an inverted hammer candlestick, barring an unexpected rally later on in the day. Also supporting the bearish case here is the fact that the momentum indictor Relative Strength Index (RSI) has been in a state of negative divergence with prices, with the RSI making lower highs despite oil prices making a series of higher highs. This divergence clearly indicate that the bullish momentum may be fading, which is significant as oil has now respected resistance.