Is This The Bottom? Balance In Oil Markets Closer Than Many Think
Is the End in Sight?
Following a week in which both Brent ($28.94) and WTI ($29.70) crude prices tumbled below $30 per barrel, it might seem premature to suggest that important preconditions for crude prices to stabilize in the first half of 2016 are forming.
This is does not mean crude prices will rally substantially, or more than a few U.S. dollars, just that some of the critical factors that have pressured prices downward over the last eighteen months show signs of abating and that this could allow a base to form under crude.
U.S. Dollar Strength Faltering
U.S. dollar appreciation against other currencies has played a significant role in the decline in crude prices. Crude is priced in U.S. dollars. As it has appreciated, it has raised crude and petroleum product prices—for unpegged currencies—in local currency terms, pressuring demand. Along with domestic issues specific to various countries (e.g., Brazil’s Petrobras corruption scandal), the appreciating US$ also sparked capital outflows, weakening economies and exacerbating downward pressure on demand.
The factors that strengthened the U.S. dollar appear to be abating. Expectations that monetary policy in the U.S.—toward tightening—will continue to diverge from monetary policy in the European Union, Japan, and China—toward loosening—are diminishing.
Coming into 2016, anticipated the Federal Reserve would follow up its December 0.25 percent increase in the Federal Funds rate with four additional increases in the course of 2016, while EU, Japanese, and Chinese central banks continued on the path to easier money.
Recent economic events don’t support that expectation. U.S. data—for example, industrial production, retail sales, business inventories, Empire State manufacturing survey—suggests the U.S. economy’s rate of growth is slowing. Estimates both for the Q4 2015 and the 1Q 2016 economic performance are falling.
An Atlanta Fed survey puts Q4 at 0.6 percent, while Q1 2016 estimates are tracking below 2 percent. Consumer price inflation remains below 2 percent on an annual basis, producer prices in December fell 0.1 percent on an annual basis, 0.2 percent on a month-to-month basis, import prices fell, and the December employment report showed a negligible increase in average hourly earnings.
Faltering economic performance in China, Russia, Brazil, and Japan and in most emerging markets—as a result of which the World Bank has cut its forecast for global growth in 2016—will reduce U.S. exports.
Two recent articles reflect the change in sentiment. On the path for Federal Reserve interest rate hikes, The Wall Street Journal January 16 reported that:
”Now, with stocks sinking as the dollar rises, the Chinese economy faltering, oil prices collapsing and U.S. growth showing signs of a slowdown, some are questioning whether the central bank misjudged the ability of the economy and markets to withstand rising rates and whether the Fed will stay the course”
On the same day, a Bloomberg described the impact on currencies:
“Japan’s currency advanced versus the dollar for the third time in four weeks, while the euro climbed versus most of its peers. Hedge funds lifted bets on yen strength to the highest in more than three years, and pared wagers against the European common currency. The greenback suffered as sentiment cooled for further currency-supportive interest-rate increases in the U.S. amid sustained market volatility and weaker-than-forecast domestic economic data”
Crude Supply Growth: Undershooting Bearish Projections?
Since the Saudis announced their intention to abandon their role as swing producer in November 2014 and reaffirmed it in December 2015, markets have anticipated that crude supply would exceed crude demand.