- OPEC gives up
- US lifts export ban
- Record Russian and Saudi output
- US rig decline and inventory build-up
- Chinese demand
- Hedge fund positioning
- NOK, CAD, the oil currencies
OPEC gives up
OPEC’s wily plan to keep supplying the market with oil, drive prices to a level that will bankrupt the competition, which will in turn reduce output and lead to price recovery is taking a little longer than first imagined.
Just like its meeting over a year ago, the latest meeting of the Organisation of Petroleum Exporting Counties (OPEC) in December sent the oil price to new multi-year lows. This time OPEC failed to even agree on a quota. An apparent row between Saudi Arabia and Iran has led to the removal of any kind of production ceiling, which previously stood at 30m bpd.
So at least until the next OPEC meeting in the summer, oil prices must reflect no production ceiling. Oil plummeted 40% after OPEC’s decision in November 2014; an equivalent percentage plunge from the time of the December 2015 meeting would take it to around $25 per barrel.
US lifts export ban
Less than a week after the US Congress agreed a deal to lift the ban on US exports, the price of front-month WTI futures, the benchmark for US crude oil briefly rose to a premium over Brent, the international benchmark. The spread between Brent and WTI has reached parity without any US export deals being signed. The US produces intermediate and light sweet crude, not the sour oil that refineries are used to receiving from the Middle East so there may be some delay before a meaningful amount of US exporting takes place. In 2016, with demand for the more desirable light sweet crude not constrained by a US export ban and supply falling as producers reduce output, the price of WTI should start to consistently trade back above the price of Brent like it did in 2010, before the shale boom.
Record Russian and Saudi output
A cutback in future capital expenditure at global oil companies will eventually reduce supply. In the short term, record oil output controlled by national governments both inside and outside of OPEC like Saudi Arabia and Russia is flooding the market, leading to over-supply and low prices. National governments are producing oil at record levels to make up the revenue deficit brought on by lower prices. The two countries are currently number one and two in the word for production and the budgets of the national governments are heavily dependent on oil revenue.
The charts below show a general uptrend in levels of production over the past five years from both Saudi Arabia and Russia, with a notable spike beginning in the summer of 2014 when oil prices first started to sink.
Chart of Saudi Arabia oil production (millions b/d) from 2010-2015
Chart of Russian production (millions b/d) from 2010-2015
US rig decline and inventory build-up
Independent US shale producers have been more responsive to price fluctuations. Production in the chart below can be seen tailing off in 2015 but still remains significantly elevated over levels of five years ago.
Chart of US crude oil production (millions b/d) from 2010-2015
The sharp decline in the number of US oil rigs from over 1900 in November 2014 to under 800 by November 2015 is expected to bring output down further in 2016 but US oil stockpiles remain stubbornly high.
DOE weekly US oil inventories & Baker Hughes rig count
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Chinese growth
The biggest fear in equity markets is that rising supplies have been met with weaker demand, notably from China, suggesting a slowdown in the global economy.
The chart below shows a trend of rising Chinese oil imports, which on the face of it, says demand is increasing. Unfortunately analysing real demand for oil is not that easy because it’s not accurately known how much of the imports are simply tactical stockpiling at low prices.
China customs crude oil imports as of October 2015 (metric tonnes)
Hedge fund positioning
Non-commercial futures positions (ie the speculators including hedge funds) as of December 2015 are the most bearish since March. This makes sense since prices were back to levels last seen in March.
The chart below shows non-commercial futures positions reaching over 0.45M in June 2014 when the oil price was below the $110 per barrel from a year earlier. So just like at the top when sentiment got very bullish when prices were flat, for oil to put in a bottom, sentiment may need another leg lower in bearishness.
Index of CFTC NYME crude oil net non-commercial futures positions
USD/NOK, CAD, the oil currencies
A combination of oil weakness and strength of the US dollar has seen a dramatic effect on the currencies of oil-exporting countries within the G10. The impact has been even more severe on Russia and could eventually lead to Saudi Arabia abandoning the riyal’s peg to the dollar.
Calling a bottom in the crude oil market is akin to trying to catch a freshly sharpened falling knife. Typically the price will bottom before the fundamental explanation for it is found. For now, with OPEC and non-OPEC countries pumping for all they’re worth, China’s economy slowing and the US dollar looking strong after the Fed rate hike, the fundamental picture looks very bearish.
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