Oil rally challenges Wall Street's bearish views

Wall Street's bearish views that oil could crater in the next couple of weeks is being challenged as crude futures bounce off 2015 highs and are now up 17 percent this month.

West Texas Intermediate futures for May surged more than 5 percent Wednesday after U.S. government inventory data showed the smallest rise in oil stockpiles this year, a drop in gasoline inventories and a slight fall in U.S. oil production. Even so, distillate product supplies rose, but the 1.3 million barrel increase in oil inventories was the smallest build since Jan. 2 and was well below the 4.1 million expected by analysts.

"I think what we're seeing here is there's a big segment of the market that is saying: 'Prices have bottomed and we are going to see output growth weaken and that's going to lead to a turnaround in prices.'" said Gene McGillian, an oil analyst at Tradition Energy. "That's why we're watching as we get above the February highs, we want to see if big volume floods the market."

WTI futures Wednesday rose 5.8 percent to $56.39 per barrel, the highest close since December. On Tuesday, WTI futures for May closed above the 100-day moving average, at just over $53 for the first time since late July. That gave strength to the argument that crude is technically strong, particularly as the dollar also gains, usually a headwind for oil.

John Kilduff of Again Capital is in the camp that expects oil to take another leg down and test its lows before it moves higher into the second half of the year. But he said the case for prices to rise is building.

"$56 is the level to watch. We've been in this range since the beginning of the year—basically $46 to $56. If we get above it, I may be the one throwing in the towel, but that's the level to watch," Kilduff said as oil surged during Wednesday morning trading. Oil traded below $56 in the electronic session after settling above it earlier.

In the stock market, the energy sector was the best performing with a 2.3 percent gain Wednesday. Bespoke Investment Group said in its recent move higher, the sector has broken its downtrend channel.

"If you're short the sector because of this downtrend, it's time to exit the trade. As of this morning, the energy sector is trading close to two standard deviations above its 50-day moving average ... so it has gotten very overbought here," Bespoke said in a note. The firm recommended investors get long the sector with the Energy Select Sector SPDR Fund ETF at an $80 entry point, just below its current level.

Besides talk of lower U.S. oil production, speculation has circulated that OPEC might want to cut output at its June meeting. Traders were also buzzing about the implications of a report that Russia and OPEC were talking, though Russia dismissed speculation that it would trim production, according to Reuters.

Russia has not cut back output, even after OPEC's November decision to hold production steady sent prices tumbling. Tensions in the Middle East have bolstered prices this week, as fighting in Yemen continues to spook the market that it could become a broader conflict.

Kilduff said Iran is still an uncertainty for the market, given the conflict between the White House and Congress over the administration's nuclear deal. "I think any signs that this Iran deal is dead on arrival will hurt prices," he said.

Read MoreOil demand seen rising but Iran calls for cut

The most bullish views among traders are for a one-two drop in U.S. production at the same time that some OPEC-related or other action sends prices higher.

"The market is looking forward to a tightening of the supply, demand fundamentals. We basically dropped $13 from the six-year low and whether we continue to rally and push above $60 or $65, I'm still skeptical. I have to see demand pick up significantly," said McGillian. "One of the things as you go into May and June, there is the increase for gasoline demand. Some of the increase can be attributed to the seasonal change we see every year. But there is chatter that Libya and Iran are calling for an OPEC cut."

Strategists have expected the market to turn when real signs of cracks start to show up in U.S. shale output, particularly as wells in operation have dropped by about half.

Traders have been watching the rise of oil in storage, speculating it could reach capacity and force a fire sale of crude at superlow prices. But those fears have been put aside for now, amid talk that U.S. output will fall. Crude stocks at the Cushing, Oklahoma, delivery hub for Nymex futures rose by 1.287 million barrels in the past week.

Closely watched U.S. oil production, above 9 million barrels a day since November, fell slightly in the past week to 9.384 million barrels per day from 9.404 million.

Read MoreSaudis, ETF trend could exacerbate oil drop: Citigroup

"The market's gotten accustomed to spectacular inventory increase for crude and this is smallish levels," said Kilduff. The decline in gasoline inventories was offset by a near-equal build in distillate stocks.

"There was a decent decline in gasoline inventories, down 2.1 million barrels. The refinery run rate is definitely elevated at this point at 92.3 percent. It doesn't get much higher than that usually," Kilduff said.

Gasoline demand, at 8.9 million barrels a day, is running at about 300,000 barrels a day above year ago levels, Kilduff said.

"There's strong refinery demand and there's strong gasoline demand. There's definitely a consumer response for gasoline here. We're pushing on 9 million barrels which is considered a very strong week," said Kilduff.

Brent, the international benchmark, was also higher, above $62 a barrel. WTI hit a low of $42.03 barrels a day on March 18, while its Feb. 3 intraday high was $54.24. Its Jan. 2 high was $55.11 per barrel.

"One week doesn't make a trend yet," said McGillian. "I think we had a little bit of technical buying when we pushed above our February highs of 54."