Crude markets managed a good solid day yesterday on the back of rumours that the Mexican tariffs may be short-lived ( a week or two) and only the first 5% tranche. The short term charts (15min) revealed strong immediate buying whenever price broke down towards the $50 range, which gave good credibility to an intraday strategy of buying into the dips.
But even though the day finished well and has maintained its gains, we have only just managed to creep back over the Weekly 200 SMA and only fingertips over the low of last week’s range. This hardly counts as a change in trend yet.
So far we are seeing further evidence of the view that market participants recognise a low around the $50 level (WTI). This is supported by a number of fundamental issues such as producer cost breakevens (i.e. you start shutting off taps when the price drops below B/E) and also that Russia has said it is content with prices around these levels (i.e. but not much lower – which can influence Russia’s attitude towards continuing the ongoing production cuts in the upcoming OPEC+ meeting).
But demand concerns are still overriding supply issues, there are still growing storm clouds over the impact of long term tariffs on slowing global economic growth. Today’s NFP may be one of those releases influencing the market for this reason.
One interesting example of the mixed impact of who gets hurt by tariffs is provided by the US imports of crude oil from Mexico. Oil is not a homogenous product and the heavy grade crude that the US imports cannot be substituted by shale oil. US refineries imported some $15 bill worth of Mexican heavy grade crude in 2018. Alternative supplies of similar crude are limited because Venezuela is restricted by its own sanctions, Canada has specific pipeline problems and Saudi Arabia is limiting its production according to current OPEC quotas.
So if tariffs are applied to Mexican oil imports that are required by the US refineries, who is going to pay the tariffs: the Mexican producer, the US refinery or the US consumer?
Another interesting story concerns the US shale companies. Several reports are showing that, whilst production is breaking new records, the bulk of the drilling companies are still not producing a positive cash flow and that there is growing difficulty in finding continuing supplies of capital to finance their operations.
According to one report over 170 U.S. shale companies have declared bankruptcy since 2015, affecting nearly $100 billion in debt, and there have been an estimated 8 bankruptcies already this year, with some $3 billion in debt restructured.
With capital markets increasingly shunning shale drillers there is a stark warning in the comment from IEEFA and the Sightline Institute that: “Until fracking companies can demonstrate that they can produce cash as well as hydrocarbons, cautious investors would be wise to view the fracking sector as a speculative enterprise with a weak outlook and an unproven business model.”
Are we seeing shale production reaching a plateau at these levels due to limited financing for additional drilling - but this issue has been around for some time and, like the US eternally increasing national debt, never seems to create a problem!
All a bit messy…