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Crude Oil Price Forecast: Omicron Fuels Weakness in Energy Markets

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Crude Oil Outlook:

  • Growth concerns around the omicron variant are provoking a burn off in oil prices.
  • A break of the November 4 low would put crude oil prices on a trajectory towards their year-long channel support, coming in closer to 71.00.
  • According to the IG Client Sentiment Index, crude oil prices have a bearish bias.

Crude Oil Prices Burn then Bounce

It’s been a month since we last checked in on crude oil prices, when it was observed that “it appears that a potential double top may be forming.” Indeed, a double top played out over the ensuing weeks, but the setback was even deeper than anticipated: the unexpected arrival of the omicron variant of COVID-19 has provoked a global growth scare. Global oil demand is highly correlated with global GDP, and thus the return of lockdowns and restrictions on economic activity – particularly in Europe – are proving burdensome for energy prices.

The turn into the second half of December has welcomed new growth concerns as COVID-19 infection rates soar in the Eurozone, the UK, and the US. Recent price action in crude oil markets warns of more potential downside in the near-term, today’s hammer at a key Fibonacci retracement notwithstanding. As COVID-19 infections are likely to continue to rise over the coming few weeks, it seems highly probable that the road ahead with remain difficult for crude oil prices; intermittent relief rallies are plausible, though.

Oil Volatility, Oil Price Correation Still Normal

Crude oil prices have a relationship with volatility like most other asset classes, especially those that have real economic uses – other energy assets, soft and hard metals, for example. Similar to how bonds and stocks don’t like increased volatility – signaling greater uncertainty around cash flows, dividends, coupon payments, etc. – crude oil tends to suffer during periods of higher volatility. Oil volatility has skyrocketed in recent weeks to the detriment of oil prices, as is expected.

OVX (Oil Volatility) Technical Analysis: Daily Price Chart (December 2020 to December 2021) (Chart 1)

Crude Oil Price Forecast: Omicron Fuels Weakness in Energy Markets

Oil volatility (as measured by the Cboe’s gold volatility ETF, OVX, which tracks the 1-month implied volatility of oil as derived from the USO option chain) was trading at 60.27 at the time this report was written. The 5-day correlation between OVX and crude oil prices is -0.74 while the 20-day correlation is -0.91; and one week ago, on December 13, the 5-day correlation was -0.26 and the 20-day correlation was -0.91.

Crude Oil Price Technical Analysis: Daily Chart (November 2020 to December 2021) (Chart 2)

Crude Oil Price Forecast: Omicron Fuels Weakness in Energy Markets

It was last noted that while “it appears that a potential double top may be forming. Momentum continues to erode in the short-term…a drop to 71.09 by the end of November would see crude oil prices return to parallel uptrend support in place off of the November 2020 and August 2021 swing lows.” Crude oil’s attempt to climb back above the November 2020 and August 2021 uptrend was rebuffed, and today’s price action felt like a wash out of sorts, with prices falling back to the 23.6% Fibonacci retracement of the November 2020 low/October 2021 high range before rebounding sharply.

The near-term upside bias may be to the topside, with a return to the December highs at 73.34 possible before the next leg lower. Daily MACD is still trending higher albeit below its signal line, while daily Slow Stochastics are close to achieving overbought territory. But given other momentum indicators’ current position – crude oil prices are below their daily EMA envelope, which is in bearish sequential order – it may be the case that crude oil prices have carved out a new range with support at 62.43.

Until COVID-19 infections accelerate to the point of shutting down western economies once more, 62.43 may not be breached; however, until the omicron variant wave runs its course, it doesn’t seem likely that 73.34 will be overtaken either.

Crude Oil Price Technical Analysis: Weekly Chart (January 2008 to December 2021) (Chart 3)

Crude Oil Price Forecast: Omicron Fuels Weakness in Energy Markets

In mid-November it was noted that “as long as crude oil prices don’t lose 71.00 by the end of November, the year-long uptrend will remain valid thus keeping a ‘buy the dip’ mentality in place even if the market declines further in the near-term.” Well, crude oil prices did lose 71.00 by the end of last month, shifting the mindset from ‘buy the dip’ to ‘sell the rally.’ Until the uptrend from the November 2020 and August 2021 lows is hurdled, then traders may want to have a cynical view towards any rally in crude oil prices.

IG CLIENT SENTIMENT INDEX: CRUDE OIL PRICE FORECAST (December 20, 2021) (CHART 4)

Crude Oil Price Forecast: Omicron Fuels Weakness in Energy Markets

Oil – US Crude: Retail trader data shows 75.16% of traders are net-long with the ratio of traders long to short at 3.03 to 1. The number of traders net-long is 11.68% higher than yesterday and 4.97% lower from last week, while the number of traders net-short is 4.45% lower than yesterday and 18.62% lower from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests Oil – US Crude prices may continue to fall.

Traders are further net-long than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger Oil – US Crude-bearish contrarian trading bias.

— Written by Christopher Vecchio, CFA, Senior Strategist