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Oil Markets Return To Supply And Demand Realities

Business, China, Company Strategy, Economics, Europe, Oil & Gas
By John Richardson on 08-Jul-2015

OIl8JulyBy John Richardson

ONLY a couple of months ago a lot of people seemed confident that oil prices had settled down in the region $60-80 a barrel. At that time, though, in my 13 May seven-point guide to oil markets in H2, I flagged up some of the risks ahead.

These risks remain, on top of which we, of course, now have the worsening crisis in Greece and the sharp correction in China’s stock markets. Hence, the steep fall in crude prices over the last few weeks.

The thing is that it was only ever sentiment that allowed oil to recover from its Q1 low point – and this sentiment was driven by speculators who chose to ignore all the continuing negative news about supply and demand.

Why did these choose to ignore this negative news? Because they assumed that central bank stimulus would continue to provide lots of  risk-free backing to go long in oil, thus enabling them keep prices artificially high and so make an awful lot more money.

But we know that in the US interest rates will have to go up, sooner or later.

And in Europe, Greece’s debts cannot be paid back. They cannot be paid back because the Greek economy is 25% smaller than when this crisis began – and it has youth unemployment of more than 50%.

But the German and other Eurozone governments are terrified of debt forgiveness. The reason is that their electorates might discover they are in line to pay the bill for Greece defaulting on its debts. The German part of the bill could easily be €86 billion, and in a worst case could be as much all of Greece’s €322 billion, according to the respected IFO Institute.

This impasse is set to overshadow everything else that the European Central Bank tries to do, including any more of its own version of quantitative easing.

As for China, for a brief while some investors felt that its stock market rallies were a “magic pill” alternative to long and painful economic reforms. People wrongly thought that by talking up equities, Beijing had found a replacement for  the lost credit-fuelled wealth effect of 2009-2013. In other words,they believed that this represented a new form of renewed major economic stimulus. This illusion will now fade away.

Interestingly, also, the handling of the stock market crisis has raised questions about the ability of China’s leaders to achieve successful reforms. This represents the shattering of another illusion, as it has long been clear that reforms would not only be difficult, but also highly uncertain.

Where do we go from here? Oil prices might recover temporarily, for sure, but I can see no reason why they will not continue to decline towards their long-term average price of around $30 a barrel.