The last 72 hours have not been good for the prospects for the global economy, and therefore for the price of oil.
On Thursday, the European Central Bank (ECB) surprised most observers by reversing course on monetary policy. They announced that they were suspending interest rate increase, at least until the end of this year, hinted that they may even return to cuts and possible negative rates, and reintroduced a program of discounted lending to banks designed to promote growth. In some instances, loose monetary policy like that could be well received by the market, being seen as a needed and welcome shot in the arm. The problem here though is not the actions taken, but the reason for them.
Mario Draghi, the ECB Chairman talked of risks to growth that were "…still tilted to the downside…" and cut the bank's estimate for growth in the Eurozone from December's 1.7% to a very weak 1.1%. He also mentioned negative rates, which suggests to many analysts that even that may be optimistic.
Now after news from China and the U.S. on Friday, Draghi's pessimism looks warranted and more like a serious warning than anything.
China released their balance of trade data last night that showed a drop in exports of well over twenty percent from a year ago. Imports were also down significantly, indicating that while the ongoing trade dispute with the U.S. is definitely a problem, the country is a deeper-seated growth issue for the world's biggest trading nation. As if that weren't enough, the other one of global growth's big three engines, the U.S. released worrying data of their own this morning. The jobs report was a huge bust, showing a non-farm payroll increase of just 20,000, woefully short of the 180,000 expected.
One should always be careful not to read too much into one month's data, and there are plausible excuses in all three cases. The ECB is dealing with Brexit, the last month in China included the Lunar New Year, and there was some exceptionally bad weather in the U.S. in February that hit construction jobs (down 31,000) particularly hard. Still, taken together, these data paint a worrying picture of a world lurching towards much slower than expected growth, or even recession.
Slow growth is always a bad thing for oil, but in the current circumstances it may be even more problematic than usual.
Over-supply was, until quite recently, a serious problem. The greater than expected output from shale fields, particularly in North America, has led to a boom in global production, as you can see from the chart below.
Figure 1: Global Oil Supply. Source: iea.org
Figure 2: WTI Futures
Yet, as you can see from the second chart, crude oil has managed to recover somewhat over the last few months from the decline that caused. There are three main reasons for that. First, there has been a feeling that prospects for global growth weren't as bad as was feared at the end of last year. Obviously, the latest data belies that.
There were also a couple of supply-related things that have lent support. OPEC and their cohorts reinforced and extended their commitment to production cuts, and while U.S. output continued to climb, infrastructure induced bottlenecks restricted the flow of crude to market to some extent.
The U.S. situation cannot be expected to last. If there is pent up demand for pipeline capacity it will be met, especially given a White House that is not prone to delaying energy projects. The OPEC cuts have the potential to be more significant for longer, but they were calculated based on assumptions about oil demand growth that are already being lowered and can be expected to drop further in the light of the most recent data.
As I said above, there is always a danger in drawing long-term conclusions from short-term data, so, as always, prudent position management is a must. However, as the evidence of a global economy that is slowing more than expected starts to pile up, positioning for a sizeable drop in oil looks like a decent trade.