Markets are under pressure. If growing global output from conventional as well as unconventional sources and the stabilizing global consumption levels - courtesy the state of major economies and the growing emphasis all around on efficiency - are any indication, crude markets are in for a slide - at least in the mid-term. And given the slow world economic recovery and unexpectedly low growth rates in China, lower oil prices seem a certainty.
As far the global economic engine is concerned, China has been the constant, the sole star performer on the global economic stage all these recent years. But things seem to be changing there too. Trend growth is slowing down and markets have been shaken up by the actions of the People's Bank of China, endeavoring to tame a virulent credit boom. In the first two months of 2014, industrial confidence and output indices, retail sales, fixed asset investment and credit creation, all were weaker than anticipated.
Slowing Chinese economic growth, chronic overcapacity and rising debt service problems in key industries are becoming more common, raising the risk of chain defaults involving suppliers and purchasers. The incidence of financial distress is becoming visible. The recent drop in the renminbi, and the sharp fall in copper and iron ore prices are the latest high-profile manifestations of China's changing outlook.
Yet, despite all this, the growing US shale oil output, increasing overall global production, the wavering state of global economy and the consequent growing possibility of a decline in crude market prices, a combination of geopolitical events in Syria, Libya and Nigeria have in the meantime, prevented any significant price slide.
But in the given circumstances, how long the markets can stand firm - above $100 - remains a big if - and a source of speculation too.
In the short term too, the overall picture is not robust. The price of oil extended losses Friday as seasonal maintenance of refineries crimped US demand and a stronger dollar made the commodity more expensive. The US dollar has been strengthening against major currencies since the Federal Reserve's new governor Janet Yellen suggested interest rate hikes could come relatively quickly after the Fed ends its extraordinary stimulus policy. A rise in the dollar makes crude more expensive in terms of other currencies.
Eminent industry pundit Philip K Verleger Jr, the former professor at the University of Calgary, a former director of the Office of Energy Policy at the US Treasury in the Carter administration and who now heads PKVerleger LLC is of the opinion that the world oil price could drop $10-$12 per barrel.
Verleger is of the view that the decision of the Obama administration to release crude from Strategic Petroleum Reserve (SPR) could impact the markets significantly, add to pressure and could have a speedy impact on Russia. The SPR now holds 694 million barrels of crude and despite the International Energy Agency requirement to hold reserves equal to 90 days of imports, the US could easily sell 500,000 to 750,000 barrels per day for up to two years without breaching this obligation, underlines Verleger. And then the veteran Washington operator suggests, 'if the US did this and all else remained equal, the world oil price would drop $10-$12 per barrel.'
And although this is only about a 10 percent reduction in price, it would still inflict substantial pain on the Kremlin, cutting its export income by around $40 billion - roughly 10 percent of the 2012 fuel export income Russia reported to the World Trade Organization, he asserts. And not only this could make Russia's GDP to fall as much as 4 percent, it could also exacerbate the ruble's decline and further increase the country's internal economic difficulties.
Weakening the markets could soon be a strategic objective for Washington, it now seems.
Brian Weepie, a researcher at S&A Resource report is also of the view that crude prices are in for a fall in near term. But his reasons are different. He points out to the rally enjoyed by crude markets over the past few months. The same situation was played out in 2013 too, and it ended with a sharp correction, he reminded. Last summer, crude oil enjoyed a large short-term rally. Prices moved from $94 per barrel in June to $108 per barrel in July. But then prices fell from $108 per barrel in August to $91 per barrel in January – more than a 15 percent decline in just over five months.
Underlining that condition similar to last summer are once again in play he asserts that when Amber Lee Mason and Brian Hunt warned last year that crude oil was due for a sharp correction, they used a simple, yet effective, indicator to predict that decline – the "Commitment of Traders (COT)."
The COT report measures the number of participants on each side (long or short) of a trading position, showing the positions of oil producers, refiners, and traders (speculators). After the rally last year, most traders were betting on oil prices rising. The COT report now also shows that the number of speculative long-side trades in the market is at an all-time high.
And when a huge number of market participants take one side of a trade, the trade often moves in the opposite direction – it's the nature of the market - he asserts. When the price drops, traders sell. The selling forces the price even lower. That's what we saw in August (2013)... and it's happening today, Weepie points out.
Since beginning this year, crude oil prices have rallied from $91 per barrel up to $105 per barrel – a 15 percent increase. Like in August last, this rally too has drawn in a massive amount of speculative traders. The number of speculative long-side trades in the market today is higher than it has been in several years. And just like in August 2013, the market today too seems ready to punish the speculators. It is hence likely the price will continue to fall as once-bullish speculators sell their positions, he asserts.
And what if the markets literally soften? One major casualty could be the growing global unconventional output. Shale development in the US and elsewhere needs a price floor. And although there is a considerable debate on what the floor could be, yet once thing remains certain. If the prices fall, even by $10-20 a barrel, some marginal fields would certainly be out of reckoning. And in turn, any dip in shale output could put pressure on overall supplies - making markets to firm up once again.
A number of factors are in play. Fundamentals continue to point to a softening market - in the near to mid-term.
