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Leonard Brecken

Leonard Brecken

Leonard is a former portfolio manager and principal at Brecken Capital LLC, a hedge fund focused on domestic equities. You can reach Leonard on Twitter.

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Weak Economy Could Stifle Oil Price Rally

Weak Economy Could Stifle Oil Price Rally

As I have explained previously, the main drivers for a sustained oil price recovery – if we shove aside all the media noise and fundamentals – will be Fed policy changes and or OPEC production cuts. It appears that both are about to happen.

First, quasi-recessionary statistics are becoming louder and louder and are now being reflected in recent earnings releases from both Apple and Boeing.

On another note, recent weakness in the service sector and continuing deterioration in capital spending and manufacturing make a fed rate hike in 2016 unlikely. At this point, the Fed will probably only hike rates once in 2016 via Fed Funds futures despite popular commentary that stresses that everything is O.K. with global GDP growth, and that the Fed will stick to its original plan for several rate increases.

At the same time EU will continue with more QE, and a similar approach in Japan seems likely. The fed is boxed in. It knows that if it comes up with more QE measures, the dollar will crash, reversing the commodity crash and adding further economic pressure on consumers in an election year. Related: Oil Prices in 2016 Will Be Determined By These 6 Factors

So what will likely happen is the following: the Fed signals it won’t raise interest levels and simultaneously enact more QE measures under the radar by threatening markets with negative interest rates (but not following through on them) in order to minimize the impact on the U.S. dollar.

The Fed statement today basically admitted that the economy has hit a rough patch, and it dialed down some expectations for a rate hike. With news today that Russia might be more cooperative with OPEC on coordinated production cuts, it appears that the moons are aligning for a rally, particularly as we emerge from seasonal refinery maintenance and U.S. output declines continue at an accelerated pace in 2016.

One fly in the ointment is demand, which according to the EIA is beginning to wane. That would make sense given the assumption that we might be headed for a recession. The EIA reported a decline in gasoline demand by over 2 percent year over year. Although I am highly skeptical of the integrity of this data, it does correspond to overall economic signals.

Thus, until pro-growth government policies are put in place, there will be a limit to an oil recovery, as demand destruction will set in from a weak economy, offsetting some of the supply cuts. Additionally, as overall equity markets continue to decline – reflecting a possible recession – it will put additional pressure on commodity prices. However, a modest recovery in the near-term is likely, especially given the record high net-short positions in oil, which are just now reacting to the policy changes above. Related: Only Recession Can Prevent An Oil Price Spike

Without much higher oil prices, oil production in the U.S. could be destined for a dramatic decline, and could exceed the modest 700,000 bpd decline that the EIA is projecting this year. As the E&P space de-levers, credit facilities continue to remain constrained and will result in capex cuts. I remain steadfast in this belief and I also think that the media has greatly exaggerated the state of oversupply in the oil market. There is a lot of hype about overflowing oil storage levels, but the record storage levels in the U.S. only amount to about 4 to 5 days above the long-term average. But the media has chosen to hype the absolute levels rather than storage in terms of ‘days of supply.’

In addition that same graph of gasoline shows days of supply is at seasonally high levels and not out of the historic range. Related: The World's Best Oil And Gas Market Just Got 115% Better

To reiterate: ‘days of supply’ is the accurate measure of inventory as it captures the effect of rising demand. However the biased media has never quoted days of supply since oil turned down, instead choosing to use absolute inventory to paint a more negative picture.

As always you can find a video commentary @lbrecken13 via Twitter/Periscope on this article.

By Leonard Brecken for Oilprice.com

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Leave a comment
  • R U Kidding on January 29 2016 said:
    "However the biased media"

    Ahh, and you are unbiased, right?
  • Ryan Brooks on January 29 2016 said:
    Thanks for the article. This adjusted my perspective on the storage issue.
  • avenger 426 on January 29 2016 said:
    The weak economy was brought about by high oil. Untill oil stays down and the economy experiences meaningful and lasting DEFLATION, there will be no recovery. There is no scenario where high oil and recovery go hand in hand. This is economics 101. Greed does not trump basic economics. Period.

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