The latest stall in the oil price forecast serves as a lesson in the weakness of sentiment-driven oil price rallies: they aren’t driven by real economic conditions, and can evaporate fast.
Let’s take a quick recap of the situation, and why the current oil price rally is deflating fast.
Oil prices rose by 27% over three days last week in the biggest rally by percentage since 1990, spurred on by reports of a U.S. production downturn and apparent willingness of OPEC to negotiate a production slowdown. (Source: CBC, last accessed September 1, 2015.)
Sounds good, right? Put together, that could spell the end of current global oversupply and correct the market imbalance which caused the oil price crash in the first place.
Oil prices dropped 28% between July 16 and August 11, but short positions increased from 83 to 193 million barrels. (Source: Oilprice, last accessed September 1, 2015.) This is a paradoxical development, because when the price of a commodity crashes, it’s logically heading towards a bottom. The closer it gets to that bottom, the riskier it is for investors to take bets on it sliding further.
Oil Price Forecast: Get Ready for Cheaper Crude
Translation: excessive betting on oil dropping even lower caused a momentary rise last week, as a bottom hit and investors rushed to get out as quickly as possible.
The reality is that there was no good reason for the oil price to rebound by $10.00 in three days. A variety of psychological factors and abstract possibilities came together to drive it upward, and they are just as quickly coming apart.
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The latest record rally has not only stalled but appears to be reversing itself, as speculation of an OPEC agreement to reduce production fades.
While crude oil rose steadily Monday on reports of lowered U.S. production, this is certainly not the end of the storm. Oil prices tanked on Tuesday, stemming from reports of a Chinese manufacturing slowdown, as well as forecasts of an increased U.S. oil stockpile. Crude oil futures dropped by as much as 4.9% on the NYSE, following the initial 27% surge in the three days leading up to Monday. (Source: The Wall Street Journal, last accessed September 1, 2015.)
Chart courtesy of www.StockCharts.com
Monday’s volume of all oil futures traded on the New York Stock Exchange was more than three times the 100-day average. (Source: Bloomberg, last accessed September 1, 2015.)
The decline in the Chinese factory gauge to a three-year low has investors justifiably nervous, as speculation grows that the Middle Kingdom’s economy might be slowing down. (Source: Financial Times, last accessed September 1, 2015.) The Chinese Purchasing Managers’ Index (PMI) was 49.7 in August, which indicates contraction.
A recent survey by Bloomberg indicates that U.S. crude oil stockpiles may have risen by as much as 700,000 barrels in the last week of August, a gain which would maintain national stockpiles 90 million barrels above the five-year seasonal average (Source: Bloomberg, last accessed September 1, 2015.)
OPEC has made it clear it won’t be willing to lift the oil price all by itself, and expects non-OPEC members to coordinate with the organization and do their fair share. (Source: Reuters, last accessed September 1, 2015.)
That really shouldn’t surprise anyone; an oil cartel isn’t going to give in without getting everyone else on board.
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Some analysts suggest that OPEC countries may begin to cut production if demand from emerging market economies begins to seriously slow down, but heavyweights such as Saudi Arabia are still well-positioned to take a massive financial beating if it means starving out rival producers. (Source: Business Times, last accessed September 1, 2015.)
Iran continues to be a wildcard. It’s maintaining the message that it will be bumping up oil production by at least one million barrels per day within five months of the lifting of sanctions, if the Islamic Republic’s Oil Minster is to be believed. (Source: Press TV, last accessed September 1, 2015.)
Is Crude Oil About to Hit $30.00 Again?
The last three days were admittedly extraordinary for oil prices, and a moderate lift was in the cards when you consider the pressure coming from short selling volumes. But there was no solid reason for the market to soar so high in so little time.
Renewed fears over what appears to be a very real slowdown in China, along with the realization that OPEC’s statement does not equal policy, are driving prices back down. Upward pressure from massive short-selling has also largely deflated, which is likely to spell the end of this so-called “rally.”
The oil price will continue to hover in the $45.00 per barrel range in the near term, and will likely drop again before the year is out, perhaps even testing new lows.
The fundamentally incorrect balance between massive global supply and slumping demand still remains, and that’s what all of the psychological factors in the oil market ultimately rest on. Market volatility can’t mask that there is still substantially more oil being produced than being consumed, and more of it is quite possibly on the way.