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Abstract: Crude oil prices tumbled from multi-year highs amid growing concerns about a global slowdown in fuel demand as the Delta variant continued to spread. However, they then rallied strongly on back of short-term positive factors across a respite in market sentiment and disruptions in Mexican oil production. On the one hand, optimism about the outlook for supply and demand will support crude prices higher in the long term. On the other hand, uncertainties over the global economic recovery and monetary policy could lead to mixed views on the current trend in the short term, and the resulting price volatility could provide more trading opportunities for investors.

Many countries around the world were responding to a surge in new infections by tightening travel restrictions as the Delta variant wreaked havoc. In China, a big consumer of crude oil, the country's zero-tolerance policy on the virus has hit demand for transport oil, a move that will slow the recovery in demand. China's airlines planned to operate the lowest number of flights in August since February following a new wave of the coronavirus, according to Bloomberg. As a result, investors' optimism about the outlook for oil demand was sharply reversed. Crude prices had fallen for a seventh straight day, with US crude and Brent crude below $64 and $65 per barrel, respectively, their lowest levels in nearly three months. In addition to the worsening virus, another major factor weighing on oil prices was the strengthening of U.S. dollar, prompted by recent hints from Fed officials that they may reduce their bond-buying program by the end of the year, which has somewhat dampened oil enthusiasm. Although the oil market still faces many headwinds, investors are betting that the decline in oil prices has bottomed out, supporting oil bulls. So, will the oil market reverse the weak trend? What are the risks facing the oil market?

As the virus continued to spread, fears about the slowing pace of the global economic recovery and the outlook for fuel demand dominated the current oil price volatility. Not only have many large U.S. companies delayed returning workers to the office, but weak economic data from China, the world's largest crude importer, has weighed on oil prices. In their latest monthly oil market reports, OPEC, the International Energy Agency (IEA) and U.S. Energy Information Administration (EIA) all expressed concerns about the Delta variant. While the virus has not affected the three institutions' forecasts for oil demand this year, the recovery in oil demand is likely to slow in the second half of the year as renewed restrictions in major consuming countries, particularly in Asia, reduce economic activity and oil use in the region. At the same time, the outlook for oil supply and demand became uncertain after OPEC+ producers agreed to increase production by 400,000 barrels per day (BPD) from August until the remaining production cuts are phased out, against a backdrop of weakening short-term oil demand.

Separately, the U.S. government urged OPEC+ to boost oil production in a bid to ease soaring inflation and gasoline prices. The move not only run counter to the Biden administration's aggressive stance on climate change, but also raised speculation about possible control measures against rising oil prices by the administration to fight inflation. But given the threat to demand from the Delta variant, OPEC+ may not be able to increase production anytime soon. Therefore, the prospect of a fitful and uneven recovery in oil demand over the long term, coupled with rising vaccination rates and a potential supply shortfall in the oil market, could support higher prices, although slowing economic growth, weakened oil demand and abated risk aversion weighed on prices in the short term.

Oil prices rose strongly as the bearish sentiment in the crude oil market gradually eased. The prospect of a flood of Iranian oil hitting the market has been greatly reduced as the talks between the U.S. and Iran on a nuclear deal that could lift sanctions on Iranian crude oil exports have stalled. Still, short-term headwinds in the oil market cannot be ignored. On the one hand, the virus has not been contained in many parts of the world, and short-term oil demand uncertainty remained. On the other hand, the Fed was likely to taper at the end of this year and raise interest rates next year, which would further strengthen the dollar and put dollar-denominated oil prices under renewed threat.

U.S. crude and Brent crude plunged by 15% since hitting six-and-a-half-year highs of $77.03 and $78.3 a barrel in early July. However, crude oil prices recently snapped a seven-day losing streak and posted their biggest one-day gain since March as risk sentiment gradually rose and the dollar weakened, as shown below:

Source from: Mitrade

In terms of technical analysis, U.S. crude oil quickly rebounded after hitting the oversold territory, possibly because oil bulls looked to buy the dips. The MACD indicator showed that the MACD line crossed above the signal line and formed a "golden cross", indicating that the oil market is building up momentum. However, the continued spread of the virus still posed a threat to the outlook for oil demand, and the bearish factors in the oil market could undermine the bullish sentiment, thus impeding the upward trend in oil prices. As oil prices rebounded strongly, short-term oil price volatility would increase.

In conclusion, despite a continued recovery in oil demand and the prospect of oil supply shortages could help support oil prices in the long term, the short-term uncertainty surrounding the virus and a shift in monetary policy could weigh on bullish sentiment. As a result, the current volatility in oil prices could provide trading opportunities against a long-term bullish backdrop.