The Downside For Oil Is Limited

More than two weeks of nearly uninterrupted price gains for crude oil ended this week, with the rally running out of steam. The question is what happens next?

Oil prices posted steep losses just as the bulls were back on the march. WTI briefly topped $70 per barrel in recent days and Brent was flirting with $80. But the rally was kneecapped by a variety of factors, and it could be challenging to break above those key pricing thresholds in the near future.

"[A]lthough the timing of the price slide comes as a surprise – Brent dipped well below $76 for a time [on Thursday] – the slide itself does not, as expectations recently have doubtless been too optimistic," Commerzbank wrote in a note. In fact, to some, the timing was not all that surprising – WTI faced technical resistance at around $70-$71, and having failed to break above that threshold, was forced back down.

But beyond the technical analysis, oil prices also face some questions on the fundamentals. The emerging market turmoil (some say crisis, or contagion) has not gone away. Currency problems continue to dog a long list of emerging market economies, pushing a few into, or to the brink of, recession.

In fact, the MSCI Emerging Market Index of equities officially fell into bear market territory on Thursday, and there is little sign of light at the end of the tunnel. "My fear of contagion is that right now the sentiment towards the whole emerging-market spectrum is very fragile," Mario Castro, a Latin America currency strategist at Nomura, said in a Wall Street Journal interview.

Because much of global oil demand growth is concentrated in rapidly-developing economies, currency weakness could have an outsized impact on crude oil demand.

"The worries about demand and a possible spillover from emerging markets are weighing on prices," Hans van Cleef, senior energy economist at ABN Amro Bank NV, told Bloomberg. "We have tested breaking higher, but that failed, so now we have a temporary setback. I still expect the market to turn higher at some point, probably driven by Iran."

Meanwhile, the Trump administration is rumored to be on the verge of dramatically ramping up the trade war with China, potentially moving forward on some $200 billion in tariffs. That would surely spark a response from China, and the back-and-forth retaliatory trade attacks could sap global growth. Also, China, specifically, is a major consumer of oil and one of the largest sources of demand growth, so a slowdown there could also go a long way to undercutting oil demand forecasts.

Also, this past week, the EIA reported weekly data that showed an uptick in gasoline inventories, a bearish sign that signals both an end to summer driving season and possibly hints at a slowdown in demand more generally. It’s one data point, however, so it doesn’t indicate a solid trend.

In fact, even as the markets sold off crude oil on the news, fearing a deterioration in the fundamentals, the reaction may have been overblown. "Gasoline demand growth has not been impressive in 2018, but total US oil demand growth has been stronger," Standard Chartered said in a note. "As for the rest of the weekly data, it was negative but also unremarkable for late August."

The softness in recent days has taken the wind out of the sails of crude oil, but it does not mean we are on the verge of another downturn. "The news backdrop does not really point to any further price slide: according to the DOE, US crude oil stocks declined by a surprisingly sharp 4.3 million barrels to 401.5 million barrels last week – their lowest level since February 2015. Things also remain interesting with respect to the Iran sanctions – particularly as far as the situation in India is concerned," Commerzbank said. "We assume that New Delhi will bow to the pressure from Washington – so the supply situation on the oil market will remain tight."

With two months to go on Iran sanctions, exports are falling fast. U.S. crude inventories are at their lowest point in years, and Saudi Arabia is going to be forced to burn through much of its spare capacity. U.S. shale, while signs of a production slowdown have yet to really materialize in the production data from the EIA, is still running into a rough patch. Just a few days ago, the CEOs of Schlumberger and Halliburton warned that drilling activity the Permian is cooling, which could translate into slower growth.

All of that is to say that while oil prices fell back at the end of this past week, it does not mean that we are in for another slide.

Link to original article: https://oilprice.com/Energy/Crude-Oil/The-Downside-For-Oil-Is-Limited.html

By Nick Cunningham of Oilprice.com

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