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Crude oil has fallen sharply over the past month. Both WTI and Brent are down around 13% since 11th April and that’s despite a partial recovery which followed a price plunge at the end of last week.

In last Friday’s Asian Pacific session crude oil experienced its very own “flash crash” as prices plummeted close to 4% in less than 15 minutes. There was no one single reason for such a move. Typically a flash crash comes about on a combination of a sudden volume pick-up in a thin market which triggers traders’ algorithms and takes prices through significant technical levels. This triggers sell-stops which exacerbates the move to the downside. Some of the most egregious examples (such as last October’s sterling flash crash) have been blamed on a “fat finger” - that is, a trader inadvertently putting in the wrong-sized order. For instance, selling 100,000 contracts rather than 100. But there’s been no indication that this is what happened last week.

The move last Friday has done extensive technical damage and has taken prices back below the levels seen early last November. This was in the days leading up to the OPEC meeting when the world’s most significant producers (except the US) agreed to output cuts of close to 1.8 million barrels per day. Back then, there were many observers (myself included) who doubted that any such deal could be reached. I then doubled down by saying even if producers agreed to output cuts, they were highly unlikely to stick to a deal as there would always be at least one country prepared to cheat. Well, I was soon eating my words as compliance has proved to be exceptionally high- way better than the 60% or so historically seen with OPEC quotas.

But what is now painfully apparent is that the cuts haven’t worked. One reason is that US shale oil production has risen sharply. The current rig count as recorded by oil services provider, Baker Hughes, stands at 877, up by 462 from the same time last year. This has caused analysts to raise their forecasts for US production, saying it could hit an all-time production high of 10 million barrels per day by year-end. This would see it consolidate its position in the top three, just shy of output from Russia and Saudi Arabia.

Also, analysts have pointed out that a production cut is not the same as an export cut. In other words, while the world’s major oil producers may be cutting back on production, that hasn’t stopped them from keeping up exports using existing inventories. But on top of that there’s increasing evidence that global demand for crude is falling, despite a pick-up in world economic growth. That would explain how global crude inventories remain at record levels.

Oil managed to steady a touch on news that OPEC and other major producers were prepared to extend their output cut agreement beyond June this year. The latest speculation is that global producers (but crucially not the US) will agree to extend the cut to the end of 2017 or even to the end of the first quarter of 2018. There is even a suggestion that producers may cut output by more than the current target of 1.8 million barrels per day. Of course, oil traders are used to this kind of jawboning from OPEC and other producers, notably Russia. And there can be little doubt that the price action over the past month must be causing panic in some quarters, most notably Saudi Arabia - given their desperation to get the best price possible for the Aramco IPO. But talks have to kick in to high gear now as the next biannual OPEC meeting takes place on 25th May - in just over a fortnight.

Of more immediate concern is the latest update on US inventories. The American Petroleum Institute (API) will report after tonight’s close while the US Department of Energy releases the official data tomorrow afternoon. There some mild support for WTI between $42.70 and $42.00 with $39-40 (last August’s low) coming in below there. But another significant inventory build has the potential to blow these levels out of the water. One would think that crude is well overdue a bounce given its recent slump. But traders are nervous, and if WTI and Brent fail to push back above $47 and $50 respectively in the near-term, further weakness is possible.

Disclaimer:

Spread Co is an execution only service provider. The material on this page is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by Spread Co Ltd or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

 

Posted by David Morrison

Category: PM Bulletin

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