Oil oils the wheel of economic growth and because ofthis its price is extremely sensitive to threats ofsupply disruptions. When hurricanes hammered down onthe United States' coastline causing the shutdown ofoil rigs many traders expected a jump in the price ofoil. It did not develop strongly but the increase inbullish pressure has remained steady with a sustainedslow rise in price. Oil at $100 a barrel is now astronger probability.
Oil has two pricing pressures. The first is the normal balance ofsupply and demand. In recent months the market has been concerned about the supply side ofthe equation with problems in the Middle East. Now the attention is shifting to the demand sideof the equation. The demand side has two factors and they are pulling in opposite directions.
The first demand factor is the slowdown in the US economy and the potential for a slowdown inthe eurozone economy. This reduces demand and puts downwards pressure on oil prices. Thestubbornly high 9 percent US unemployment rate is weighing on oil prices. This, and weak USmanufacturing figures, suggest the US is not emerging from its economic slowdown.
Add to this the dismal outlook in the eurozone with the collapse of the DAX and the FTSE andits clear message that the brakes will be applied to global economic growth. An economicslowdown reduces oil demand and contributes to pressure for lower prices.
Lower oil prices also have an adverse effect on other energy industries because they lose theprice advantage against cheap oil. Higher oil prices boost the competitiveness of solar,vegetable oil-based fuels and other energy solutions. Lower oil prices increase the profitpotential of heavy-oil using industries such as aviation and should, in theory, lead to lowerairfares.
The second demand factor is the potential for some type of new quantitative easing policy inthe United States. This will create more cheap money. This "hot" money does not stay in theUnited States. Investors put it into new investments that deliver better returns. One of theseinvestment areas is commodities such as oil which is accessed using exchange-tradedcommodity funds. This creates upward pressure on prices that is not related to changes indemand. This speculative pressure creates a bubble.
The chart of NYMEX oil prices reflects these conflicting global slowdown pressures but it alsoshows a developing bullish breakout. This signals the potential to increase global inflationarypressures. The NYMEX oil chart shows two significant features that help establish the limits ofthe consolidation breakout.
The first is the long-term upward trend line started in August 2010. It was broken in June 2011with a fall below $96. This was a clear break in the trend. This also signaled an importantchange in the nature of the trend line. From August 2010 to June 2011 this line acted as asupport level. Now this line acts as a resistance level, repelling any price rally.
This resistance line will provide a limit to future price rises and rally breakouts. It makes it moredifficult for prices to lift above $105, the current value of the trend line.
The second feature is the pattern of support and resistance levels. These help to define thedownside and upside targets for price movements. Oil found support at the historical supportlevel near $78. The next higher resistance level is near $88. This level has been broken with asmall breakout. This breakout needs to retreat and retest $88 as a support level before abreakout is fully confirmed. A breakout above this level has the first upside technical targetnear $98. The psychological resistance level is $100.
The price movement between consolidation bands is often very rapid. This reflects strongreactions to significant changes in political or economic events. When oil is trading below $100the pattern of support and resistance bands are around $10 wide. A breakout above $88 canmove quickly to $98. A move below $78 can drop quickly to $68.
When oil moves above $100 the behavior of the market changes. The first change is anincrease in volatility. The price moves up and down more rapidly and more frequently betweensupport and resistance levels than when oil is below $100. The second change in behavior isan increase in the width of the support and resistance bands to around $12.
Currently oil is developing a breakout from the trading band between $78 and $88.Conformation of quantitative easing measures that will boost the US economy will see a veryrapid confirmation of breakout from the consolidation pattern with an immediate upside targetnear $98 to $100. The threats of hurricanes and the normal increase in demand with the onsetof winter also add to the bullish pressure.
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