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Nick Cunningham

Nick Cunningham

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Oil Plunges On Fears Of Weak Demand

Oil prices sank once again on Wednesday, falling on flagging oil demand and growing fears of an economic slowdown.

The EIA reported another jump in crude oil inventories last week by 2.2 million barrels, which helped exacerbate the selloff. A string of inventory gains has fueled fears of weak demand at a time when other economic indicators are flashing red. 

Demand is weakening in large part because of a deceleration in the global economy. Weak indicators continue to emerge from China and Europe, as well as in the United States. As John Kemp for Reuters points out, major trading hubs around the world reveal a sharp slowdown in global trade, with freight volumes down significantly compared to last year, which suggests the global economy is on the verge of a recession.

“Demand expectations for 2019 have so far been unrealistic,” Mark Maclean, managing director at Commodities Trading Corp., said in a Bloomberg interview. “China has slowed faster than people expected and the trade war is still having a significant impact, the EU will not be a pocket for demand growth this year and the U.S. is also problematic.”

Meanwhile, refining margins are cratering in northwest Europe, offering more evidence of stagnant demand, according to Bloomberg. Prices for products such as gasoline and naptha have fallen faster than those for crude oil. A downbeat market for naptha suggests weak demand for plastics. Bloomberg noted that margins on paraxylene, a substance needed in the production of clothes and water bottles, are near a five-year seasonal low. Similarly, ethylene margins, used in plastic bags, have fallen into negative territory. Related: Small Crude Build Sends Oil Lower

The deterioration in oil demand is finally getting recognition from major oil forecasters. The EIA said on Tuesday that 2019 global crude demand would be lower than previously expected. In the agency’s Short-Term Energy Outlook, it lowered its demand estimate to 1.2 million barrels per day (mb/d), nearly 200,000 bpd lower than last month’s projection. “EIA’s lower 2019 Brent price path reflects rising uncertainty about global oil demand growth,” the agency said, justifying a $3-per-barrel downward revision. Meanwhile, U.S. shale production is expected to grow by less than expected because of lower prices.

But a series of Wall Street banks are much more pessimistic than the EIA and the IEA. Morgan Stanley sees demand growing by 1 million barrels per day (mb/d). JPMorgan Chase puts growth at 800,000 bpd for 2019, nearly 40 percent lower than the IEA’s estimate of 1.3 mb/d.

Still, the economic gloom significantly increases the odds of an extension of the OPEC+ cuts, which could prevent a deeper slide in oil prices. “Extending the production cut agreement by a further six months should prevent an oversupply on the oil market and support a price recovery in the second half of the year,” Commerzbank wrote in a note.

Saudi and Russian officials apparently discussed a scenario in which oil might plunge below $40 per barrel, although it seems unthinkable that the group would fail to extend the production cuts. “A scenario when they don’t extend cuts is not going to be pretty,” Warren Patterson, commodities strategist at ING, told the Wall Street Journal. Related: Escalating Trade War Signals More Pain For Oil

For its part, analysts at Goldman Sachs see an extension likely, with key OPEC+ members (i.e. Saudi Arabia) balancing the market on a monthly basis going forward – ramping production up or down depending on what the market needs. That would suggest the group goes a long way in maintaining a supply/demand balance. Goldman stuck with a $65.50-per-barrel price forecast for the third quarter.

However, the investment bank acknowledged that a sharp slowdown in demand would throw this scenario out the window. OPEC would be unable to cut fast enough to keep up with the decline in demand. “OPEC production adjustments have historically not been able to match the velocity of demand declines during recessions, leading to rising inventories, contangoes and lower prices,” Goldman analysts wrote, before adding that such an outcome still seems unlikely.

Worryingly, however, is the Trump administration’s ongoing trade war with China, which could yet escalate into a new phase. Earlier this week, Trump said that he could hike tariffs on the remaining $300 billion of Chinese imports of Xi Jingping refuses to meet with him later this month in Japan on the sidelines of the G20 summit. He added that he could impose a 25 percent levy, or “much higher than 25 percent.”

By Nick Cunningham of Oilprice.com

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