Wednesday, May 22, 2013

Does Oil Now Have A Price Ceiling In the $98-$100 Area?

The chart above shows that since the beginning of 2013, oil has hit the $98-$100 price area four times.  Each time, it has retreated.  The question is, why?

There are several potential reasons:

1.) Overall, world growth is slow.  The strongest country -- China -- is in the midst of a slowdown (albeit from 10% growth to 7%).  All other economies are experiencing similar slowdowns.  Some parts of the globe (the EU) are in the middle of a prolonged recession.

2.) Commodities are losing their investment luster: the drop in gold was perhaps the icing on the cake, but all other commodities are struggling to make price gains.  With inflation low and the dollar stronger, commodities just aren't needed right now.  Hence an exit from this asset class by hedge funds:

Money managers are the most bearish on commodities in more than four years as a majority expected a weaker Chinese economy for the first time in 14 months, a Bank of America Corp. survey showed. 

A net 29 percent of the fund managers surveyed were underweight the asset class in May as their positions “collapsed” to the lowest level since December 2008. One in four now consider a “hard landing” in China as the biggest risk to their investments. The bank surveyed professional investors who together oversee $517 billion.

3.) The development of the US shale oil market has sent "shockwaves" through the oil markets:

North America will provide 40 percent of new supplies to 2018 through the development of light, tight oil and oil sands, while the contribution from the Organization of Petroleum Exporting Countries will slip to 30 percent, according to the International Energy Agency. The IEA trimmed global fuel demand estimates for the next four years, and predicted that consumption in emerging economies may overtake developed nations this year. 

“The supply shock created by a surge in North American oil production will be as transformative to the market over the next five years as was the rise of Chinese demand over the last 15,” the Paris-based adviser to 28 oil-consuming nations said in its medium-term market report today.

The development of U.S. shale resources, enabling the nation’s highest level of energy independence in two decades, is creating a “chain reaction” in the global transportation, processing and storage of oil that may escalate as other countries try to replicate the American oil boom, according to the IEA. Crude futures for settlement in 2018 are trading at a discount to current prices, signaling expectations for increasing supplies and constrained demand.