It’s amazing how quickly markets can shift their perceptions of a commodity. This latest oil price rally is purely psychological and has very little to do with actual market fundamentals, which are still alarmingly soft if the latest data is to be believed.
In a week increasingly marked by short-term volatility, oil prices hit their worst point in six and a half years on Monday to close under $38.00 per barrel.
Crude oil prices, however, shocked traders by surging by more than 10% on Thursday. Following several days of languishing in the sub-$40.00 range, West Texas Intermediate (WTI) was rejuvenated on news of better-than-expected U.S. quarterly gross domestic product (GDP) growth. (Source: BBC, last accessed August 27, 2015.) This positive news combined with a surprised drawdown in U.S. crude oil stockpiles, gave uplift to the black gold and helped propel it nearly $4.00 to the mid-$42.00 range on Thursday afternoon.
This Oil Price Forecast Reveals Where Rates are Going Next
For crude oil, Thursday was the largest one-day reversal since March 2009.
Equity markets also regained a substantial part of Monday’s steep losses, as hopes rose that Beijing would come to grips with its stock market crisis.
The oil price forecast was awash with optimism, as front-month Brent crude futures shot up by 10% to $47.00 per barrel. (Source: EIA, last accessed August 27, 2015.)
Various analysts have explained the oil price’s renewed upward momentum as partly driven by investors being caught off guard and closing out short bets against an expected market drop. (Source: The Wall Street Journal, last accessed August 27, 2015.) When prices started to climb, skittish traders began shorting oil stocks in an effort to minimize their losses. Bets on oil falling were at their highest since April at the beginning of this week, if data from the U.S. Commodity Futures Trading Commission can be believed (Source: CFTC, last accessed August 27, 2015.)
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When bearish predictions prove wrong, the resulting wave of investors rushing to get out can paradoxically make the situation even worse, driving the price of a commodity up even further. This is exactly what happened in yesterday’s trading.
Let’s move away from speculation and move on to facts, then. I’m talking about market fundamentals.
A profound supply and demand imbalance still remains. And it’s only going to get worse in the next few months. Total global oil production stands at 95.66 million barrels per day, while daily consumption lags considerably behind at 93.62 million barrels per day. (Source: IEA, last accessed August 27, 2015.)
Global stockpiles are still rising. They’re in fact hitting record levels of 1.283 billion barrels, if you combine both crude and refined stockpiles. U.S. crude stockpiles may hit 500 million barrels in fact, which is a record. (Source: EIA, last accessed August 27, 2015.) Despite crude stockpiles declining somewhat unexpectedly last week, when you combine stockpiles, refined fuels are at a record level.
But if the EIA’s report on Wednesday states that total U.S. oil and refined fuel stockpiles surged to a record level, why are American producers still pumping over 9.3 million barrels per day? What will happen to this imbalance once we enter fall refinery maintenance season next month?
Speaking of which, there’s an additional factor to consider.
From a financial point of view, this is an extremely sensitive period for upstream energy companies. September will be the next lenders’ review of lines of credit backed by oil reserves. What does this mean, in practice? Well, the lower the price of crude oil, the lower the amount of credit your organization will be extended. I think it’s fair to say that oil executives are losing more than a little sleep as they pray this latest rally extends into the next few weeks.
Debt levels among commodity producers are dangerously high, and while the effects take time to translate into market movements, a financial reckoning may well be coming.
Think about this: the 10 largest mining companies in the world have an all-time record of $145 billion, while profits are at their lowest since 2009. (Source: Bloomberg, last accessed August 27, 2015.)
The crest of the latest debt-wave will be mergers and acquisitions, and it has already begun.
Don’t buy into the hype. This latest rally is momentary blip on the financial radar before reality takes hold of the oil price and drives it below $40.00 per barrel again.