The West Texas Intermediate (WTI) crude oil futures contract has broken psychological support at $50 after a 2.5-month, 40% mini-crash that started in the upper $70s. The implications are deeply bearish because this instrument may be acting as a co-incident indicator, dropping due to growing odds for an economic slowdown. If so, supply cuts may not staunch the bleeding, setting the stage for a test at decade-long support in the low $30s.

U.S. energy stocks have sold off to one- and two-year lows in recent weeks, with many large-cap components now testing the deep lows posted in the first quarter of 2016. If you recall, no one was talking about the benefits of low-priced crude oil during that system shock, which generated many calls for an economic collapse similar to 2008. Look for similarly bearish sentiment if selling pressure continues into 2019.

Crude supply issues have dominated energy headlines throughout 2018, with Iran sanctions and the record-setting pace of U.S. production forcing OPEC to look at output cuts to stabilize prices. The U.S. now produces more than 11 million barrels per day while a free-wheeling president insists that demand will eventually catch up with rapidly growing supply. This is a dangerous combination in an industry marked by extreme boom and bust cycles.

Crude Oil Chart (2005 – 2018)

Chart showing price performance of crude oil

WTI crude oil broke out above four-year resistance in the low-$30s in 2004, lifting in a historic trend advance that topped out near $150 in 2008. It plunged during the economic collapse, finding support at the 2004 breakout level a few months later. A recovery wave ended near $114 and the .786 Fibonacci sell-off retracement in 2011, giving way to a broad symmetrical triangle pattern that broke to the downside in 2014.

The sell-off into 2016 ended a few points under the 2008 low, yielding a modest uptick that carved three waves into the .618 retracement of the two-year decline and trendline formed by the 2008 and 2014 peaks. The current downturn has now relinquished nearly 60% of the gains posted between 2016 and 2018 while carving the final wave of a 14-year descending triangle. At a minimum, this bearish structure should eventually generate a test at the 2008 and 2016 lows. 

Energy Stocks in Retreat

Price action in U.S. energy stocks has followed suit in recent months, dumping a few well-known names into their 2016 lows. Oil services has taken the biggest hit so far, with the VanEck Vectors Oil Services ETF (OIH) breaking decade-long support and dropping into a test at the 2002 low, which also marks the all-time low. In turn, this predicts that components still testing their 2016 low will offer profitable short sales.

Technical chart showing the performance of Halliburton Company (HAL) stock

Halliburton Company (HAL) shares topped out in the mid-$50s in 2008 and sold off into the low teens during the economic collapse. The stock bounced into the prior high in 2011 and reversed, eventually posting a higher low in the mid-$20s. A 2014 rally hit an all-time high at $74.33 before turning tail in a failed breakout that generated another trip into the low teens in 2016. The stock is now trading less than two points above this critical support level.

A breakdown has the potential to generate an additional 50% haircut that dumps the energy giant into the 2008 low. Just a single support level lies between the breakdown level and that downside target, generated by a steep 2010 sell-off that reversed at $21.10 (black line). More importantly, a bounce starting in the low $20s is unlikely to gain traction because the stock will be trading below heavy resistance at the .786 Fibonacci retracement of the six-year uptrend in the mid-$20s.

The Bottom Line

WTI crude oil has dumped into the mid-$40s after topping about above $75 in October. This brutal decline signals the next down leg of a complex 10-year downtrend that is targeting support in the low $30s. Energy stocks have dropped in sympathy during this rout and are now testing multi-year lows.

Disclosure: The author held no positions in the aforementioned securities at the time of publication.