Last week witnessed oil’s worst decline so far this year and took us back to March price levels. So is this the start of a new downtrend or just an over-reaction to a breakout from a longish, rather narrow, consolidation period?
The sell-off was initiated by the EIA data released last week showing another build in crude oil stocks compared with an anticipated draw. But raw crude is not the only inventory item included in the EIA data. In fact, one source stated that:
”The main reason why the EIA data was so negative was because inventories rose in all categories except residual fuel oil, resulting in a combined increase of 16.33 million barrels”.
But whilst the US inventories are high profile, they do not show the entire global situation and the US market has its own factors affecting stock build-ups including high production rates in the shale region and a lack of physical pipeline to transport it.
But the bearish tone is not just about excessive supply. The black clouds gathering over the black gold are also due to concerns over the global growth outlook. Cracks are beginning to appear in the growth prospects of many countries in the fall-out from the US-China trade war.
There are serious concerns that the global economic situation has reached a peak and that there now prospects of a new oil glut forming. And this fear seems to be overiding the geopolitical pressures right now. For example, the IEA said that global oil demand grew by 640,000 bpd in the first quarter year-on-year, which is a notable downward revision from its previous estimate of a 1mill bpd increase.
We have recently seen a lot of news about outages from Venezuela and Iran, as well as problems in other producer countries and pipeline contamination in Russia. And we have also seen high-profile prospects of proxy wars in the Gulf. But in spite of so much potentially bullish news being thrown into the ring, the markets didn’t react at all – and then came the EIA data……
Whilst there is no doubt that oil is reacting to genuine economic concerns, it is unlikely that the OPEC+ group (which meets again in June) will discontinue or ease their current production restrictions if there is any sniff of a new oil glut on the horizon. So this is more likely to be only a temporary correction to an otherwise somewhat stabilised supply/demand situation.
Whilst the buildup in inventories and weakness in prices are mostly the result of a perceived widely spread reduction in demand, mostly due to the trade war, the supply concerns are still very much present. Whilst many of these risks are already accounted for, there are still political instabilities in other producer area, like Libya, that can enter into the supply equation at any time.
Also, although the current concerns regarding the US-China trade wars are a real and present danger, how likely is it that the leaders concerned are really going to allow this to degenerate into a full crisis and a global recession?
Mr Trump, for sure, has his eye on the looming presidential elections and low oil prices and a strong economy and equities markets must be high on the agenda as the accountable results of the ”America First” campaign so far.
In addition, oil is not a homogenous commodity and an over-supply of US shale does not compensate for shortages in other grades due to the geopolitical constrictions.
Oil is living exciting times once again – and trading opportunities arise alongside it!