Crude oil stabilises after major capitulation slump
The rout in crude oil accelerated and resulted in the potential final round of capitulation selling last Tuesday when Opec's Monthly Oil Market Report
confirmed what bulls increasingly had come to fear: Surging production from non-Opec producers, especially the US and Russia, and reduced demand for Opec’s own oil at a time when the market was already troubled by signs of slowing demand growth into 2019. Adding to this, we have the reduced impact of US sanctions against Iran’s export ability after Washington unexpectedly granted waivers for some countries, including some of the world’s biggest buyers.
The 7% drop in WTI crude oil and 6.6% drop in Brent were the worst one-day losses for these benchmarks in three years. It looked like a classic capitulation move with bulls finally throwing in the towel following weeks of relentless selling. It now raises the question of whether the market has overshot to the downside, just like Brent did to the upside at the beginning of October when it hit $87/barrel.
We believe that it has, with our assumption being based on the following observations:
Crude stocks are likely to begin falling soon once global refinery activity ramps up after maintenance.
Saudi Arabia has been played by the US over Iran and they are angry. Together with their friends they are now considering cutting production by 1.4m b/d (Reuters).
Speculators have sharply reduced their net-long positions with some of that being due a rise in gross-short positions. A price recovery will force renewed buying and short-covering.
Many refineries have limited use for the very light US shale oil compared with heavier qualities from the Middle East. A cut in ME barrels will increase the cost of middle distillate products, such as jet fuel, heating oil and diesel. Note Diesel (ULSD) already trades at a multi-year high spread relative to gasoline (RBOB).
The 20% drop in Brent crude oil since early October has come as a major relief to emerging market consumers already struggling with a strong dollar, high levels of dollar debt and the rising funding cost of funding it.
Several oil producers can ill afford the slump experienced since early October and on that basis, we can expect both Opec and Russia to step up their attempts to stop the rout and guide crude oil higher. Russia, which has based its 2019 budget on an oil price of $40/b, will be content with Brent at $70/b, while Saudi Arabia is desperate for a price closer to $80/b.
In the short term Brent crude could climb back towards $73/b (38.2% retracement as per chart) and even higher ahead of year end.