For the second time in less than a week, the price of oil has dropped several percentage points over the course of several hours. On June 14, WTI dropped almost 4% to below $45 a barrel and on June 20, WTI dropped as much as 3% before closing at $43.23, a 2.2% drop.
Although the media has tried its best to explain these recent tumbles as the result of either higher-than-expected crude oil stocks (June 14) or growing production from Libya and Nigeria (June 20), there really are no clear cut explanations for the recent slate of sudden and swift price drops.
Increasing production from Libya and Nigeria is an easy culprit for the most recent drop, but this explanation is insufficient since both countries have telegraphed these increases for the better part of a year. These increases were clearly presented at the May OPEC meeting and the market accounted for them at that time. News in June of gradual production increases (Libya +50,000 bpd and Nigeria + 62,000 bpd in August) should not cause a sudden price drop of this magnitude.
Other culprits for the sudden drops could include the following:
- Refinery runs in the U.S. last week averaged a near record high of 17.6 million barrels per day. Even if crude oil inventories for last week show a decline, various industry reports are forecasting a build in U.S. gasoline stocks.
- Many hedge funds, led by prominent oil fund Andurand, see crude oil falling in the near future and are taking positions to reflect that expectation.
- Reports indicate that the number of DUCs (drilled but uncompleted wells) in U.S. shale fields is continuing to rise. (According to the EIA there were 5,946 DUCs, the most in 3 years, at the end of May). This could indicate that production in shale fields will continue its growth pattern.
On the other hand, there are many signs indicating that oil may soon be on the rise.
- OPEC reports that compliance with the joint OPEC and non-OPEC production cuts was at a record 106% for the month of May.
- Saudi Arabia reports that its oil exports dropped 3% in April and that its oil production continues to remain below 10 million bpd.
- The sub $50 a barrel prices, combined with higher service costs, could negatively impact shale producers in the coming months. Also, a slew of larger companies are acquiring assets from smaller companies. Typically, this would lead to a slowdown in drilling because larger companies can afford to ease up when smaller companies cannot.
- Saudi Arabia’s oil minister, Khalid al-Falih, said that “market fundamentals are going in the right direction,” and that the current OPEC cuts need time to impact the market because of the extreme surpluses. He wrote off the recent drops as the work of speculation and “unpredictable variables beyond the control of producing nations.”
- The Chinese government announced that the second batch of import quotas for 2017 for its independent refineries would grow by 1.83 million bpd. This means that non-state owned Chinese refineries (so-called “teapots”) will be able to import even more crude oil, providing the market with some idea of Chinese demand for the rest of the year.
- In the immediate short term, oil prices could jump on word that tropical storm Cindy has formed in the Gulf of Mexico, prompting some producers to shut down offshore rigs and the Louisiana Offshore Oil Port (LOOP) to stop unloading tankers.
What we are most likely seeing now is a reaction to the fact that there is no strong indicator about where the market is heading. In the absence of strong signs, the market tends to magnify certain speculative moves by major financial institutions. This could have manifested in sudden drops (or spikes), like the one seen on June 20.