How Low Can Oil Go?

Six months ago, I wrote a detailed report warning about the bubble in crude oil and why it was likely headed for a bust. That was on June 9th, when light sweet crude oil was trading at $102 per barrel; in less than two weeks, the crude oil bubble reached its peak, and plunged to just $66 today – a 35 percent decline that took the world by surprise. Since then, this report has gone viral with over 175,000 views.

Though I plan to write a detailed follow-up report explaining what I foresee for crude oil and the shale energy industry after this bust, I’d like to use this post to briefly show some of the key charts that are relevant for determining crude oil’s next immediate move.

On Black Friday, OPEC announced that it will not cut production to shore up oil prices, which caused oil to crash by over 10 percent that day alone. Friday’s plunge caused light sweet crude oil (the U.S. oil benchmark) to sink below its $70 support level. If this break below $70 can be sustained, $60 is the next obvious support level that crude may try to shoot for.

At some point, a bounce or consolidation may occur as crude oil is quite oversold on a technical basis. One scenario is that crude tries to touch $60 or just above it and consolidates before its next major directional move. If the $60 support level is broken, $40 (the early-2009 lows) is the next major support level to watch.

Source: Barchart.com 

Brent crude oil (the main benchmark outside of the U.S.) sliced under its $90 support level and is now sitting just above its $70 support level. As with light sweet crude, there is a good chance that brent crude will experience some sort of bounce or consolidation in the near future as it tries to work off its oversold condition. Brent crude may start to consolidate off of the $70 support level or just above it. If $70 is eventually broken, the next major or obvious support level is found all the way down at $40.

Following the U.S. dollar is key to understanding the crude oil market. The U.S. dollar trades inversely with commodities including oil, and its moves often affect crude oil prices very strongly. The U.S. dollar’s rally since July was one of the primary reasons why crude oil plunged when it did. Traders who can successfully forecast the direction of the dollar can apply this knowledge to forecasting crude oil.

A few months ago, the U.S. Dollar Index climbed above its diagonal resistance line and is now just below its $90-$93 resistance zone. If the Dollar Index can surpass this resistance zone, the bearish case for crude oil will likely persist. If the Dollar Index experiences some sort of pullback or consolidation in the near future (possibly under the $90-$93 zone), then both brent and light sweet crude oil are likely to experience consolidations or bounces of their own. It is possible that the Dollar Index will consolidate under $90-$93 before attempting a bullish breakout above this level.

A major possible bullish factor for the dollar is the eventual unwinding of the multi-trillion dollar global carry trade that was encouraged by the Fed’s ZIRP and QE policies. This carry trade helped to inflate bubbles in assets across the world, as I discussed at the beginning of all of my emerging markets bubble reports. The ending of this carry trade will harm the inflated assets that benefited from the carry trade, while the dollar will rally.

Source: Barchart.com 

As I wrote in my original crude oil bubble report, I believe that the popping of the oil bubble will also lead to the popping of a bubble that developed in the U.S. shale energy industry. To summarize, the shale boom was driven by a combination of artificially high oil prices after 2009 and cheap credit in the form of junk bonds that were used to finance the shale producers’ drilling activities.

Many shale oil companies have production costs in the $70s, so a sustained drop below this level will cause many of these companies to shut down and lay off workers. The energy industry is notorious for its violent booms and busts, so another bust would certainly not be unprecedented. The early-1980s oil bust severely harmed the oil-dependent economies of Texas and Oklahoma.