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Why Are The Oil Markets Crashing?

Crude Oil

WTI and Brent continued to tumble on Thursday, dropping to their lowest levels since the announcement of the OPEC deal back in November. Brent actually dipped below $49 per barrel, raising fears of another downturn. Both WTI and Brent were off by nearly 4 percent during midday trading on Thursday.

Oil traders have been patient, hoping that despite the rapid rebound in U.S. shale production, the OPEC cuts would take a substantial volume of oil off the market and correct the supply/demand imbalance. But it has been a painful and protracted process.

U.S. crude oil inventories hit a record high of 535 million barrels as recently as the end of March. Several consecutive weeks of drawdowns in April again raised hopes that the market is heading towards balance, but the most recent data release from the EIA on May 3 disappointed yet again, and it was apparently the last straw for some. Market analysts predicted a drop in oil inventories by about 2.3 million barrels, but the EIA said stocks only fell by 930,000 barrels. WTI sank to $46 per barrel and Brent fell into the $40s for the first time in 2017.

Worse, gasoline stocks increased slightly, offering more evidence that motorists are not willing to burn through all the refined products that the downstream sector is producing. Even if refiners suck more crude out of storage, consumers won’t sufficiently burn through all of the additional refined product. Related: Tech Breakthroughs May Save Deepwater Oil

But the most bearish part of the report came from the upstream figures, which once again showed dramatic growth in U.S. oil production. In the last week in April, the industry added another 28,000 bpd, taking U.S. output up to 9.293 million barrels per day (mb/d), up more than 200,000 bpd since the beginning of March, and up more than 450,000 bpd since the start of the year. Output is now the highest since the summer of 2015, and if current trends continue, the industry could break all-time production records before we know it.

U.S. oil production “continues to grow hand over fist, and the market will remain well oversupplied given the lack of” demand for gasoline and diesel, Roberto Friedlander, head of energy trading at Seaport Global Securities, told CNBC.

It is growing more difficult by the day to make the case that oil prices will post strong gains this year. A WSJ survey of 14 investment banks finds an average projected Brent oil prices for this year at $57 per barrel, an estimate that is starting to look a bit overly optimistic.

"Crude inventories fell, because they always do at this time of year," Stephen Schork, president of Schork Group Inc., told Bloomberg. "This is the 11th straight-weekly gain in production and heading for a modern-day record by the end of the year. I don’t see any way you can spin this as bullish."

Adding to the supply glut is the fact that Libya has restored large chunks of its production, taking output back above 700,000 bpd. Libya’s National Oil Company is also targeting another 500,000 bpd of gains this year, although that will be easier said than done.

Things are not all bad. On the plus side, hedge funds and other money managers have reduced their bullish bets on crude oil, which is to say, they are not overextended on the upside in the way that they were the last time oil prices fell. That means there is less pent up pressure that could suddenly force prices down further. "We've had some pretty sharp price corrections already so it does reduce the risk of length liquidation. I do think as long as OPEC maintains the cuts, the price will get some stability," Petromatrix analyst Olivier Jakob said to CNBC. Related: The Oil Crisis: An Ice Cream-Flavored Asteroid?

And although it gets lost in the mix, especially when prices start getting volatile, the market is still marching slowly in the right direction. Inventories are declining globally, and many analysts still see more balance later this year.

Moreover, the markets tend to put too much emphasis on one indicator over another. OPEC was given enormous credit in the initial rally up to $50 last November, but some argue that the large OPEC cuts, which are likely to be extended through the end of the year, are now being discounted as everyone shifts their focus to the shale comeback. "U.S. production continues to rise largely in response to supply discipline being shown by OPEC and Russia," Tim Evans, an energy analyst at Citi Futures Perspective, said in a Bloomberg interview. "It was a mistake during the first part of the year to ignore rising U.S. production and focus exclusively on the OPEC cuts. It’s a mistake now to just focus on U.S. production and assume that guarantees we’ll have an ongoing abundance of supply."

But the problem with that argument is that to a large degree the OPEC extension has already been priced into the markets. That leaves little upside to an extension but a massive risk to the downside if OPEC fails to extend.

By Nick Cunningham of Oilprice.com

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  • Jeffery Surratt on May 04 2017 said:
    Drill baby drill. Even at $45 per barrel oil is overpriced. With 10,000 boomers retiring each and every day, and more EVs and hybrids coming in the next 2 years oil should be $40 or less. The world economies need cheap energy to support 7 billion people and governments should do everything in their power to keep oil prices low.
  • Timmie Tee on May 04 2017 said:
    I'm still long but believe current production is facing contango and being sold forward and stored, thus skewing the inventory numbers. Also, if the majority of current shale production is from DUC wells, I wonder if new shale projects will get funded at $45, thus ending the rise in U.S. rigs? The longer oil is below $60, which I believe is the magic number to fund conventional exploration, the higher the spike will be when inventory finally does balances.
  • Brett Ingham on May 04 2017 said:
    If you are an investor, or any other human interested in world economics, you are missing out on the greatest story of the decade if you have not followed the story in oil over the past 2 1/2 years.OP

    We have witnessed the greatest transfer of wealth known to mankind from the oil producing nations to the oil importing nations. But, that is not the headline, not by a long shot. The headline is that THEY HAVE DONE IT WILLINGLY!!! OPEC flooded the market with oil in 2015 expecting to collapse shale production. This was a huge gamble that cost them 2 trillion dollars so far! More losses are to come!! All due to stupidity and arrogance!!!

    You see, OPEC (mostly Saudi Arabia) believes they can command the price of oil world wide through manipulation of output...Yep, I know what you're thinking, stuck in the 70's! Only one problem...they have little itty bitty gnat balls. Yeah...you see, they say they're going to bring down inventories by cutting less than 5% of their output...riiiiiight! They increase 10% to destroy shale then cut 5% and bring it back into balance. I DON'T THINK SO!!!

    Here is what OPEC is missing: Oil importing countries commonly have diverse economies with little reliance upon their oil industry to generate GDP. As a result, the oil producing parts of their economies deal with razor thin profit margins, and are very aggressive at innovation to protect and increase those margins. OPEC has been fat and happy, with many deadbeats in their populations sucking their profits out of their cheap oil or.

    Bottom line - the oil market will be drawn back into a realistic pricing scenario sometime in the future, but don't look to OPEC to
  • rajendra on May 05 2017 said:
    ISRO has designed solar car. That will be for common man and middle class (It will on indian roads soon). By this India want to get rid of Oil dependency by 2030.
    Post 2030 India don't want to produce single petrol car and be self reliant on energy.
  • Will on May 05 2017 said:
    Well done to the US shale industry trying to bankrupt itself again. All Saudi has to do is open up the taps again and the yank idiots are back in the welfare queue.
  • andrew redford on May 05 2017 said:
    The conspiracy theorist in me wants to believe that the slide in oil is partially caused by parties interested in a fire sale of Saudi Aramco IPO.
  • Disgruntled on May 05 2017 said:
    Plain and simple, the US oil industry jumped the gun. False start. They'd better get back on the starting line or they'll be DQ'd.

    In other news, OPEC cut production to about 28 mmbopd back in 2008-09 to deal with the global recession. They have it in them so that's not the problem. I think the "war on shale" continues with both sides having some minor battle victories.
  • Naomi on May 06 2017 said:
    However low the price of oil, shale drillers must drill to pay interest on their loans. Bankers must lend to drillers or the drillers stop paying interest on their loans.
  • L S Rand on May 06 2017 said:
    The author fails to mention there was a 1.5mm barrel release from the Strategic Petroleum Reserve. Without that, inventories would have been 2.43mm bbl lower, or more than estimates. Total petroleum stocks are below a year ago, indicating the market has been at least in balance for the last year (and probably in deficit given declines in floating storage over that period). If there has been such a huge glut of supply since December 2014, where are the 1 billion barrels of excess supply hiding?
  • Asad Rizvi on May 07 2017 said:
    @asadcmka

    Saudi Arabia should Delay ARAMCO Sale

    I fully support Saudi Vision 2030, as basic idea is "Economic Prosperity". But I have reservations about its public announcement to sell 49 pct stake in ARAMCO in next 10 years.

    Despite Shale factor, Aramco selling is the other major cause of lower crude prices to buy its shares at a cheaper price and hence, oil prices will remain under pressure until 5 pct IPO is sold.

    In my humble view Saudi government should reconsider its proposal to offload 5% of its stake via IPO in 2018, which is estimated to generate USD 100 Billion. On an average if Oil prices is higher by $ 20 (annually) it will generate nearly USD 75 Billion.

    Saudi Arabia should announce delay in selling of ARAMCO stake until further notice or postpone selling until next 5-years and see the magic or else prices will once again dip down to average around USD 40.

    https://asadcmka.wordpress.com/2017/04/24/saudi-arabia-should-delay-aramco-sale/

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