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What’s Behind The Crash In Crude?

Thursday, December 20th 2018 - 08:38 UTC
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Crude prices fell 4% on Monday and about 7% on Tuesday. WTI dropped below US$47 per barrel and Brent fell to the US$56 handle. Crude prices fell 4% on Monday and about 7% on Tuesday. WTI dropped below US$47 per barrel and Brent fell to the US$56 handle.

Oil prices crashed to new one-year lows on Tuesday, dragged down by a deepening sense of global economic gloom as well as fears of oversupply in the oil market itself.

The reasons for the sudden meltdown were multiple. Rising crude oil inventories and expected increases in shale production weighed on oil prices, but the price crash was accentuated by the broader selloff in financials.

Genscape said that inventories are rising, which has raised fears of tepid demand amid soaring supply growth. “The Cushing number came in higher than anticipated ... it's definitely pointing to the concern that there's more supply and demand is weakening,” said Phil Flynn, analyst at Price Futures Group in Chicago, according to Reuters.

“The market is still very nervous about that.”

Crude prices fell 4% on Monday and about 7% on Tuesday. WTI dropped below US$47 per barrel and Brent fell to the US$56 handle.

The EIA said in its latest Drilling Productivity Report that it expects U.S. shale production to top 8.1 million barrels per day (mb/d) in January, rising by a massive 134,000 bpd month-on-month. The Permian alone will see production rise by 73,000 bpd next month. By way of context, the gains in the Permian are bigger than even some of the large monthly declines that we have seen in Venezuela, for instance.

Still, with WTI dropping below US$ 50 per barrel, shale drillers will start to face increasing financial strain. That could force a slowdown in the shale patch. “We’re probably going to see a supply slowdown in the U.S.,” Michael Loewen, a commodities strategist at Scotiabank, told Bloomberg. “I do think that producers will react.”

But the malaise sweeping over the oil market can also be chalked up to broader fears of a global economic slowdown. U.S. equities crashed on Monday and stocks in Asia were also sharply down on Tuesday. The Dow Jones Industrial Average is down 12% since early October, and in fact, the S&P 500 is down nearly 5 percent on the year.

Rising interest rates have been blamed for increasing borrowing costs, strengthening the U.S. dollar, injecting volatility into emerging markets and setting off capital flight in some countries.

More importantly than this week’s rate hike will be direction from the Fed on what it plans to do next year. Originally, the central bank had hoped to keep rate hikes on track, but financial volatility could force it ease up. A softer tone could provide some relief for financial markets, as seems to have happened this Wednesday.

With inflation low in the U.S., and heightened volatility and weak growth seen elsewhere, many economists question the wisdom of continuing to hike interest rates.

“If monetary policy doesn’t change its direction, you will have a significant meltdown on this,” Steven Ricchiuto, chief U.S. economist with Mizuho Securities, told the New York Times. “So there’s a lot riding on it.”

But the problems could be deeper. The U.S. housing market is showing signs of strain (higher interest rates have certainly not helped). Auto sales in Asia are down. Germany saw its GDP contract in the third quarter. The U.S.-China trade war has already inflicted damage on the economy and could still grow worse. Unless there is a rebound in stocks over the next two weeks, 2018 could be the worst year for U.S. equities since 2008, which is all the more remarkable given the steep rally that unfolded over the first half of the year.

A general economic slowdown would likely cut into oil demand figures for 2019. It’s an ill-timed development for OPEC+, which just announced production cuts in order to try to balance the market. An economic downturn would make OPEC+’s job much more difficult. “The stabilization on the oil market is already history…and the effect of the announced production cuts after OPEC’s meeting has evaporated entirely,” Commerzbank said in a note.

By Nick Cunningham

Categories: Energy & Oil, International.

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