Crude Oil Price Crash for Dummies

Hello Readers,

The recent crude oil price crash is second only to spread of the COVID-19 globally in panic terms. The base for almost all fuels, as we know, has lost nearly 50% from the high of $65 per barrel in last 3 months, of which, nearly 32% has been recorded in the past 5 trading days alone. Crude oil prices are falling like a rock under the influence of gravity.

Two questions come to my mind here-

1) Why?

2) Until where?

To answer the first question first, we know crude oil prices are determined by two primary forces- demand and supply.

On the demand front, China has ceased to be the primary manufacturer, favourite cuisine or  emerging world economy and garnered a new reputation as the epicentre of a pandemic. In the heart of all things that China was best known for, it was also the biggest consumer of crude oil, but come 2020 and the advent of the COVID-19, it has come to a standstill with visibly lower demands for crude as organisations have stop manufacturing operations and people have stopped travelling.

The impact of this is much larger than ever priced in any scenario analysis. The pandemic has touched nearly 115 countries. The globally cascading effect of the disease- operational shutdowns, travel bans- is bound to have a palpable negative impact on demand for crude oil.

Now, the logical solution in a situation of demand set back would be to cut production. However, what is adding oil to the fire here is the current supply flux. OPEC collapsing after the failure of negotiations between Saudi Arabia and Russia to cut production in the face of an already suffering demand paradigm came as a shock for the global trading community as witnessed via the price crash.

Moving on to the next question ’until when’.

The simple answer is- no one knows. However, what we can identify using techniques of technical analysis is a probable support level for WTI Crude Oil. But before that, let’s look at the daily and monthly price charts below.

On the daily price chart, the breach of an important ‘triple bottom’ support level of $42.20 last week, combined with a ‘runaway gap’ is a knell bell and a text book set up for further price decline. The slight bounce in price witnessed after the piercing fall is popularly known as a ‘dead cat bounce’. In simpler language, it means that the bounce has no credibility, it is only an acknowledgement of the knee jerk reaction witnessed in price.

However, if we take into consideration the monthly chart above, the current price crash does not look quite as bad as those witnessed in the past. In both the big fall we have witnessed so far (2008,2014), price has forged a lower high and a lower low at every turning point, thereby confirming a primary downtrend. By definition, the term ‘bear market’ is used when a script/index/future contract has lost more than 20%. However, we are playing with much bigger numbers and calling it a mere bear trend does not do justice to the scenario we are looking at. What is worth noting is that, during both the past price crashes, support came in at approximately 70% price decline from the last peak.

To conclude, having brought to attention similar instances of price crash that have happened till date and taking into consideration that the threat of this pandemic is as real as the financial crisis of 2008 and in fact more global in nature, the pain should at least be at par with the past incident, if not worse. This brings us to the end with a lingering question that would crude prices be driven to a range of $18 to $21PB?  The potential support range incidentally is also the only price support visible on the monthly chart which is below the triple bottom support that was breached earlier this week.

Thank you, for reading!

Regards,

Kavita Chamaria