Key Points:
- Iran/Iraq split with OPEC over production targets.
- Crude oil collapses over 10% in the past week.
- Oil rebalancing still occurring and any rally will ultimately be self-defeating.
Crude oil has fallen under the auspices of a bearish cloud of late which has seen the commodity decline by over 10% over the past week. The rout was largely kicked off by a build in the US Crude Oil Inventories but was further exacerbated by an obvious split between OPEC members. However, prices look to have stabilised in the near term during early trading but the question remains as to how long they can delay the inevitable bears.
Despite Thursday's intra-day gains the general sentiment for crude oil remains highly bearish. The fact that Iran and Iraq have decreed that they will consider themselves unbound by any production quota just reinforces the fact that OPEC has lost their teeth in the current market environment. As domestic economic pressures continue to influence government budgets the last thing that any OPEC members need right now is a reduced market share.
The reality is that OPEC enforced production caps are unlikely to strongly move the market anymore given the level of supply from non-members and the ultimately fungible nature of crude markets. The current level of market integration implies that such a move will simply cause further rebalancing within global crude markets and lead to market share shifting to non-OPEC countries.
In addition, many of the Middle Eastern OPEC members are suffering from the ongoing historically low oil prices and this is impacting both foreign currency reserves and fiscal revenues. Subsequently, the last thing that many of these nations need is a further drop in royalty revenues without any form of long term gains from increased prices.
Therefore, the great OPEC supply cap experiment was always going to fail miserably and further expose friction between the member states. The reality is that the new oil order still requires plenty of rebalancing within global markets and an acceptance that shale oil and oil sands production have discovered efficiency gains over the past few years that reduce the marginal extraction cost and change the very nature of world crude markets.
Further compounding any upside moves for the commodity is the fact that demand growth has remained relatively timid over the past quarter. In fact, Barclays estimates that Q3-2016 demand growth is less than 30% of what it was in the same period last year. Obviously, this isn’t a global market that can sustain price hikes in the medium term given the current fundamentals.
Ultimately, there is plenty of pain still to come for producers before the rebalancing of crude markets completes and short term price hikes only delay that process and prolong the pain. Although it is true that much of the supply glut has moved through the global supply chain we still face an abundance of productive capacity which is likely to mean prices will remain depressed in the medium term. So don’t bet on any sustained price gains in the medium term as you are likely to get your fingers burned.