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Oil is not well

September 2015

Sustained oversupply and flat demand projections dent hopes of an early recovery in crude oil prices. Where’s the bottom? by Nidhi Modi

History is repeating itself in the crude oil market. After a gap of six years prices are again testing sub $40 levels. High volatility in prices has become a norm of the day in a host of commodities, especially crude oil. The US crude oil price futures slipped below $40 a barrel at New York Mercantile Exchange on August 21.

After some recovery in the month of June, price has come under a greater pressure. Marred by an oversupply and stable output, price has corrected around 35 per cent since June. The world has now seen an entire year of a bearish trend in crude oil. Forecasts of recovery in second half of 2015 now seems unlikely. Crude oil had been largely stable during the period from 2010 till mid 2014.

The International Energy Agency said in its August Oil Market Report that the sharp fall in crude oil during July and August is triggered by abundant supply and a strong US dollar. “From the driller in the Bakken (shale oil field in US) to the motorist at the pump, oil market players are adjusting to a world of lower prices. While a rebalancing has clearly begun, the process is likely to be prolonged as a supply overhang is expected to persist through 2016 – suggesting global inventories will pile up further”, said the Report.

Crude producers have come under pressure due to sagging prices. But refineries are enjoying healthy margins. Margins do not vary with crude oil prices but economics of refinery business improves. Also, while producing economies like those in the Middle East, Russia and US feel the pressure of decline in prices, those reliant on imports for bulk of consumption (such as India) are in a sweet spot. For producers the decline in prices will manifest in a lower Gross Domestic Product and cut in spending while the importing nations can invest resources in other sectors. Another challenge for producing nations is to maintain output since not all oil fields will be viable at current prices.

Producers’ group, however, remain hopeful of a recovery. “Given the better-than-expected growth in global oil demand so far this year, together with some signs of a pickup in the economies of the major consuming countries, crude oil demand in the coming months should continue to improve and, thus, gradually reduce the imbalance in oil supply-demand fundamentals”, the Organisation of Petroleum Exporting Countries said in its August Oil Market Report.

OPEC expects the global oil demand to grow 1.38 million barrels per day in 2015 and the total oil demand to reach 92.70 million barrels per day. For next year, it expects world oil demand growth at 1.34 million barrels per day with total world consumption hitting a record level of 94.04 million barrels per day.
Crude oil inventory in US is estimated to have increased to 456 million barrels in the week ended August 14, almost 30 per cent more than the five year average. US, home to a shale oil revolution, has more challenges in store. Refineries in neighbouring countries like Canada now prefer to expand import of crude oil from distant producers like Saudi Arabia due to improved economics. The US shale boom had brought shale oil prices to a competitive level compared to the traditional crude oil.

It is worrying that a recovery in oil global demand has not followed the decline in prices and oversupply. Problems in major consuming nations like China and US dominated sentiments. The Chinese factory activity slipped to the lowest in two years and registered its fifth successive monthly contraction in July. Consumer confidence index in the US weakened to an eight month low. Forecast for global economic growth is unchanged at 3.2 per cent in 2015 and 3.5 per cent for 2016.

A cocktail of factors like Eurozone’s debt challenges, a possible rate hike in the US and concerns on an overcapacity in China will determine the way global economy will move from here. Prospects of Iran’s likely return into the global crude oil market next year will also have a bearing.

Oil has company from a host of commodities in this declining phase. “Oil’s fall was not alone – it was a commodity-wide collapse, with all major commodity values hitting their lowest level since 2003, erasing almost all the gains of the decade-long commodities’ “super-cycle”, fuelled by China”, said the OPEC report.

Understandably, money is getting pumped away from crude oil trade. Hedge funds and money managers are turning bearish on future prospects. Speculators, traders and funds are reducing position in crude oil futures. West Texas Intermediate long positions contracted over 50 per cent in July to a two-year low and short holdings climbed 55%.

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