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$20 Oil Is Now A Distinct Possibility As Chinese Demand Wanes

$20 Oil Is Now A Distinct Possibility As Chinese Demand Wanes

Oil prices continue to hit new lows. WTI and Brent traded down by more than 2 percent during midday trading on Monday, as the markets continue to digest the worrying economic news coming out of China.

There are several reasons why China is spooking the financial markets. The most obvious is the latest plunge in the stock market. The Shanghai Composite fell another 5 percent on January 11, as the stampede that began in late December continues. The index is down about 20 percent in the past two weeks, and is off about 40 percent since June 2015. The wild gyrations and the haphazard response from the Chinese government has created an atmosphere of instability.

More importantly for crude oil is the fact that China’s worsening economic situation could cut into the country’s crude oil demand. And that happens in multiple ways. First, a decelerating economy by itself will lead to slowing demand growth for oil. That is already starting to show up in the data. In November, for example, China’s oil demand fell by 2 percent compared to the same month in 2014. In fact, since last summer, China has posted weak demand figures, and consumption growth turned negative in November. The contraction could be temporary, but the slow down might not be. China’s consumption growth might hit just 300,000 barrels per day in 2016, down from the 500,000 barrels per day averaged over 2015, according to a Barclays’ analyst quoted by Bloomberg. Related: Crashing Oil Prices And Dropping Rig Count Take Their Toll On U.S. Output

Yet another way that China could put downward pressure on crude oil is from the depreciating yuan. The slowing economy is leading to a weakening of the currency, and a weaker currency will make crude oil more expensive, which will further cut into demand.

As the world’s principle driver of crude oil demand suddenly starts slowing to more pedestrian levels of growth, the oil markets are very much feeling the effect.

Meanwhile, Goldman Sachs published an intriguing conclusion in a research note on Friday after the investment bank hosted a closed-door energy conference in Miami. The investment bank was struck at the perspective that many shale companies have today, given the current state of affairs with oil trading in the low $30s per barrel. Goldman said that oil producers are not facing up to reality, and continued to stress their individual capacity to weather the downturn without suffering production cutbacks, according to Reuters. Moreover, many avoided specifics about how crude oil near $30 per barrel would affect their operations. Many companies are still using $50 per barrel as an operating assumption when presenting their outlooks for 2016. Related: Rig Count: Capitulation?

The problem is that oil is not $50 per barrel, and could be a long way from rebounding to that point. Some might say that oil CEOs are too optimistic about a rebound in prices. A less charitable view would be that basing a company’s metrics on an oil price ($50) that is more than 50 percent higher than actual spot prices today ($32) is actually pretty delusional.

"Investors were looking for fear and trepidation from producers but got agility and below-expected clarity instead," Goldman Sachs said in its January 8 research note. "At our conference, producers largely did not provide specifics on what capex/production would look like at $35/bbl oil," the note went on. "Instead, producers spoke largely of their agility to spend within cash flow and... ramp up when needed." Related: Shocking: ISIS Attacks On Libyan Oil Facilities Visible from Space

The conference confirmed the investment bank’s pessimistic outlook for crude oil prices. Goldman Sachs made waves last year when it predicted that oil might fall into the $20s per barrel. Given the irrational optimistic that apparently pervades the shale industry, $20 crude might be needed to force the needed cutbacks in production, as Goldman said all along. The bank said that it will likely take a few more months before the industry’s “mindset” starts to grapple with the ramifications of oil staying at $40 or below. Until that happens, Goldman believes, oil companies will continue to pump into an oversupplied market.

At the same time, the producers at the Miami conference suggested that they could begin to ramp up production further when oil hit $50 per barrel. The ability for some drillers to flip the shale switch back on at $50 could extend the slump, as supplies merely come back as oil rebounds.

But before that happens, oil prices might need to fall into the $20s per barrel.

By Nick Cunningham of Oilprice.com

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  • Amvet on January 12 2016 said:
    How can Chinese oil demand be dropping when Chinese oil imports were up 8.7% June to Nov this year and up 7.6% in November??

    Also in December Chinese auto sales were up 18%. More autos = less oil demand ??

    Why do you keep talking down the oil price ???
  • Matt on January 12 2016 said:
    Let them talk the oil price down. The figures you cite, if true, point to the supply-demand imbalance self-correcting eventually. When buyers for physical oil have a bit of trouble securing their supply, that will ripple immediately through the markets, and price will go up, possibly quite dramatically. That said, it appears to me that a propaganda campaign is being waged in order to create a dismal psychological environment for all commodities, but oil in particular. The fact is that the oversupply on a 95 mmbopd demand is probably less than 2%. That seems pretty tight to me. Like "just in time" supply. This situation will run its course, either when demand catches up to supply or Saudi Arabia comes to its senses.
  • Oil Trader on January 12 2016 said:
    fwiw, I remember the days when there was all the talk about peak oil, combined with demand from China and India, oil could blow sky high to $200 - and oil was trading @ ~ $140. I was short and had to change diapers often :) That rhetoric was very nerve wracking. After all, China (and India) were seen as these two gigantic markets beginning to 'come on line' with their combined populations of 2.5 billion, that meant industrial production, lots of cars on the road, lots more than ever before.

    Well, I am changing my diapers all over again, but I have a different trade :) Short @ 130 - 140 was pretty scary, because there was fresh money supply hyper-inflation going on and, well, with commods the sky is the limit and 0 is as low as you can go.

    Here we have a $15 (?) downside risk? Hard to say. It is hardly a $30 downside risk. And the fed's little .25 bump probably wont be repeated for a long time to come, and that means little to no dent in the money supply, which today is still 4x greater than it was the last time prices were here.

    Breaking the 2009 low took the bounce out of the bid, so the tone is terrible. The short term kick ass guys are doing great on the short side and I admire them and their trade. They are deeply in the money, and have little incentive to take their boots off of a buyer's neck. Plus the 'fundamentals' are total s* (for a buyer). Massive over-supply, *perceived* demand issues connected to gyrating stock markets, and then the real reason, political espionage to destroy the economy of Russia and get rid of Putin.

    Oil is iNsAnELy oversold, but when big players cram down the bid because they have bigger fish to fry, well, what are you gonna do? Pretty soon, somebody is going to cry uncle, and this shorting down here will be a distant memory. The currently painted high for the year is ~$38, and the prev close ~$36.5. Seems hard to believe the market will stay away from those prices for the rest of the year. And if they keep the pressure on like this for a while longer (4-6 months), when/if the bid ticks up through the previously yearly settlement, that will translate into up for the year. And with all this exaggerated selling into the dungeon now, by that time, there will be no looking back, and you can pretty much kiss these prices good bye for a very long time.
  • Luís on January 14 2016 said:
    Every other media is presenting figures around 9% growth for the consumption of petroleum products in China. There are also recent news of record imports of many other commodities in December.

    Considering the low rate of motorisation per capita in China and Brent at 30$, an inversion in consumption growth looks quite remote.

    Cheers.
  • Phil on January 15 2016 said:
    It is the combination of things. China is not growing as expected and the world is trying to figure out what to do with all this oil. We are seeing the most open oil market in 50 years. It's crazy time folks. There are many economies around the world that are suffering because of these low prices. Russia is hard hit. Any country that has oil as it's main commodity is hurting. China is hurting for cash and is selling off some of the US treasuries it bought when we passed the debt to them. Some think that could drive up inflation here. It's all gonna settle out, but it will take time. We should be able to weather this if we don't panic. Might be hard to do in an election year with all the rhetoric.

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