By John Richardson
THE continuing failure of genuine price discovery in oil markets was perfectly summarised by the the Wall Street Journal today, when it wrote:
Commodity hedge funds added $4.1 billion in the first quarter, their best quarter in more than six years, eVestment said Monday. That trend is still supporting oil prices now, giving the rally a sense of invincibility and punishing anyone who has bet oversupply will drag prices back.
Please, please be careful out there. If you are an oil trader or financial speculator on the right side of this rally, job well done. But if you are involved either in producing or buying petrochemicals, the above paragraph from the WSJ serves as an important warning.
Thanks to analysis from my colleague, Paul Hodges, here are some salient facts about today’s crude markets that you must consider.
Analysts are looking in the wrong direction when they try to relate the recent 50% increase in oil prices to changes in the fundamentals of oil market supply and demand. The International Energy Agency, for example, reported earlier this month that OECD stocks built counter-seasonally in February, and said this trend had continued into March.
In Asia, China’s slowdown has led to a dramatic expansion of its diesel exports, which were up three-fold in March versus 2015 at over 1 million tonnes, whilst gasoline exports were up 9% at 670,000 tonnes. This oversupply has led gasoline margins in Singapore – the Asian pricing benchmark – to halve to just $7/bbl since the start of the year.
US inventories also remain near record levels. They are reducing slightly as we move towards the start of the US driving season on Memorial Day (May 30). But this is simply a seasonal effect and doesn’t change the underlying picture of oversupply.
The much discussed “production freeze” between OPEC and Russian producers has also failed to deliver any results – and in any case, would only freeze production at today’s near record levels in the main producers.
The real cause of the oil-price increase has been the newly dovish tone from the US Federal Reserve on its interest rate policy. Markets began the year believing that the US recovery was finally underway, and that there would be four interest rate rises in 2016. Instead, US GDP has weakened once again, and markets now think any rate increase could well be postponed until December at the earliest.
As a result, the value of the US dollar has weakened sharply against other major currencies such as the euro and the Japanese yen. This has prompted the traditional rally into commodities such as oil. These are traded in dollars and are seen as “stores of value” against a devaluing dollar. This move is also being supported by the new stimulus programmes introduced by the Bank of Japan and European Central Bank, which are providing speculators with a tsunami of very cheap money.
This combination has led to a surge in buying by financial speculators in oil and gasoline futures markets, which –as the above quote from the WSJ points out – has been at record levels in recent weeks.
My concern remains that not enough people are connecting all the dots. Gillian Tett’s concept of “silo thinking” continues to be instructive here, as does the Daniel Kahneman concept of “anchoring”. These important concepts tell us these four things:
- You could get away with “silo thinking” during the Economic Supercycle (see the above graphic). Whether you were on oil trader, or say a petrochemicals feedstock purchasing manager, all you had to worry about was measuring the supply of oil, as strong demand growth was guaranteed.
- But the Supercycle is over, meaning that we are beyond peak Demand Growth for Oil. Crude should and would, therefore, still have been where it was in January if it hadn’t been for yet more distortions of true price discovery, resulting from further waves of Central Bank stimulus.
- This doesn’t meant that effective oil market analysis doesn’t have to factor in the fluctuating supply of crude. Supply analysis remains critical, with lots of useful debate about the short term supply outlook available to all of us.
- But if you don’t factor in a.) The Supercycle (I am, as always, very open to convincing arguments about the why Supercycle isn’t over), and b.) The role of central bank money, you cannot provide effective analysis of oil markets.