Nymex Light Crude is headed for another test of support at $45/barrel. Breach would signal a decline, with a medium-term target of $35/barrel*.
* Target calculation: 45 – ( 55 – 45 ) = 35
Saturation of available storage capacity (see Crude in Contango) is expected to force sellers into the market and drive prices lower.
Nymex WTI Light Crude is testing resistance at $54/barrel, while Brent Crude is at $62/barrel. WTI above $54/barrel would signal a bear market rally, but is likely to leave the primary trend unaltered. Breach of support at $45/barrel would signal another decline.
The crude oil market is in contango, with spot prices lower than future prices, encouraging traders to store oil until prices rise. But Leslie Shaffer reports that oil storage is nearing full capacity:
“We’re going to see pretty fast inventory builds over the next few weeks,” Francisco Blanch, head of commodity research at Bank of America-Merrill Lynch, told CNBC Wednesday, noting that global supply is running around 1.4 million barrels a day above demand.
“If you run out of space, prices tend to react a lot more violently to adjust that supply and demand imbalance and that’s what we expect over the next few weeks,” he said, forecasting both WTI and Brent will fall toward $30 a barrel.
By Houses & Holes
Reproduced with kind permission from Macrobusiness.com.au
From Jeremy Grantham:
The simplest argument for the oil price decline is for once correct. A wave of new U.S. fracking oil could be seen to be overtaking the modestly growing global oil demand.
It became clear that OPEC, mainly Saudi Arabia, must cut back production if the price were to stay around $100 a barrel, which many, including me, believe is necessary to justify continued heavy spending to find traditional oil.
The Saudis declined to pull back their production and the oil market entered into glut mode, in which storage is full and production continues above demand.
Under glut conditions, oil (and natural gas) is uniquely sensitive to declines toward marginal cost (ignoring sunk costs), which can approach a few dollars a barrel – the cost of just pumping the oil.
Oil demand is notoriously insensitive to price in the short term but cumulatively and substantially sensitive as a few years pass.
The Saudis are obviously expecting that these low prices will turn off U.S. fracking, and I’m sure they are right. Almost no new drilling programs will be initiated at current prices except by the financially desperate and the irrationally impatient, and in three years over 80% of all production from current wells will be gone!
Thus, in a few months (six to nine?) I believe oil supply is likely to drop to a new equilibrium, probably in the $30 to $50 per barrel range.
For the following few years, U.S. fracking costs will determine the global oil balance. At each level, as prices rise more, fracking production will gear up. U.S. fracking is unique in oil industry history in the speed with which it can turn on and off.
In five to eight years, depending on global GDP growth and how quickly prices recover, U.S. fracking production will start to peak out and the full cost of an incremental barrel of traditional oil will become, once again, the main input into price. This is believed to be about $80 today and rising. In five to eight years it is likely to be $100 to $150 in my opinion.
U.S. fracking reserves that are available up to $120 a barrel are probably only equal to about one year of current global demand. This is absolutely not another Saudi Arabia.
Saudi Arabia has probably made the wrong decision for two reasons:
First, unintended consequences: a price decline of this magnitude has generated a real increase in global risk. For example, an oil producing country under extreme financial pressure may make some rash move. Oil company bankruptcy might also destabilize the financial world. Perversely, the Saudis particularly value stability.
Second, the Saudis could probably have absorbed all U.S. fracking increases in output (from today’s four million barrels a day to seven or eight) and never have been worse off than producing half of their current production for twice the current price … not a bad deal.
Only if U.S. fracking reserves are cheaper to produce and much larger than generally thought would the Saudis be right. It is a possibility, but I believe it is not probable.
The arguments that this is a demand-driven bust do not seem to tally with the data, although longer term the lack of cheap oil will be a real threat if we have not pushed ahead with renewables.
Most likely though, beyond 10 years electric cars and alternative energy will begin to eat into potential oil demand, threatening longer-term oil prices.
Exactly right, though in my view the equilibrium price will be more like $50 than $30 for the next half decade.
Don’t miss the full report.
The latest newsletter from Absolute Return Partners suggests that the fall in oil prices is temporary and oil will soon recover to around $100/barrel:
“All I know is that the price of oil won’t stay below the production cost for a long period of time (as in years). Hence I think we will see the oil price at $100 again, and it won’t take many years, but it could be an extraordinarily bumpy ride.”
The chart below depicts crude oil prices (WTI) from 1987 to 2014, adjusted to current (November 2014) prices.
What it shows is that, prior to 2004, crude oil prices seldom exceeded $40/barrel. If, for most of the 17-year period, prices were below $40/barrel and supply continued unabated, then production costs must be even lower. Some of the more accessible oil fields may be nearing the end of their life, but production costs for major producers such as the Saudis could not have changed much (in real terms) over the last 10 years. That means true production costs are a lot lower than ARP’s estimate.
I tend to side with Anatole Kaletsky who views $50/barrel as the likely ceiling for crude oil prices — and not the floor.
Posted by Houses and Holes. Reproduced with kind permission from Macrobusiness.
Goldman’s Tim Toohey has quantified the unwinding commodity super-cycle for ‘Straya’:
Lower commodity prices risk $0.5trn in forgone earnings
The outlook for revenues from Australian LNG and bulk commodities shipments – which account for almost half of total export earnings – has deteriorated significantly. To be clear, overall revenues are still forecast to increase substantially over the coming years – underpinned by a broadly unchanged strong outlook for physical shipments (particularly for LNG). However, in a nominal sense, the outlook is far less positive than before. This owes to a structurally weaker price environment, with GS downgrades of 18% to 25% to key long term price forecasts for LNG and bulk commodities suggesting that cumulative earnings over the years to 2025 are on track to be ~$0.5trn lower than previously forecast.
… and will erode Australia’s trade/fiscal positions
The deterioration in the earnings environment naturally has direct implications for Australia’s international trade and fiscal positions. On the former, a return to surplus by CY18 no longer looks feasible, and we now expect a deficit of ~$15bn. On the latter, relative to the 2014 Commonwealth Budget, we estimate that weaker commodity prices will cause a ~$40bn shortfall in tax revenues over the next four years. Given our expectation that Australia’s LNG sector will deliver no additional PRRT revenues over the coming decade, and the ~$18bn downgrade to commodity-related tax in the December MYEFO, we therefore see a risk of further material revenue downgrades at May’s 2015 Budget.
Resulting in changed GDP, RBA cash rate and FX forecasts
Although the commodity export changes mainly manifest through the nominal economy, there are significant impacts back through to the real economy. Lower export earnings result in lower profits, lower tax receipts, lower investment and lower employment. We continue to expect just 2.0% GDP growth in 2015 but have lowered our 2016 to 2018 real GDP forecasts by an average of 50ppts in each calendar year. As a consequence, we have moved forward the timing of the next RBA rate cut to May 2015, where we see the cash rate remaining at 2.0% until Q416, where we expect a 25bp hike. We now expect just 75bps of hikes in 2017 to 3.0% and rates on hold in 2018. Despite the recent move in the A$ towards our 75c 12 month target, the reassessment of the medium term forecast outlook argues for a new lower target 12 month target of 72c.
OK, that’s quite a piece of work and congratulations to Tim Toohey for getting so far ahead of pack. I have just two points to add.
The LNG forecasts look good but as gloomy as his iron ore outlook is, it is not gloomy enough. $40 is a more reasonable price projection for 2016-18 and we’ll only climb out of that very slowly. That makes the dollar and interest rate forecasts far too bullish and hawkish.
Second, even after these downgrades, Mr Toohey still has growth of 3.25% GDP penned in for 2016 and 3.5% for 2017. We’ll have strong net exports and is about it. With the capex unwind running right through both years, housing construction to stop adding to growth by next year, the car industry wind-down at the same time, political strife destroying the public infrastructure pipeline, the terms of trade crashing throughout and households battered half to death by all of it, those targets are of the stretch variety, to say the least.
The analysis is exceptional, The conclusions, sadly, overly optimistic.
West Texas Crude has been falling since breaking support at $75/barrel, following through below $50/barrel. A test of 2009 lows at $30/barrel is likely unless there is major disruption to supply.
When we adjust crude prices for inflation, they remain high by historical standards. Prior to the China boom of the early 2000s, the ratio of WTI Crude to CPI had seldom ventured above $20/barrel when measured in 1982-1984 dollars (shown as 0.2 on the chart below). After the dramatic fall of the last 3 months, the adjusted price at the end of December 2014 (in 1982-1984 dollars) is still $25.20/barrel (0.252 on the chart) — well above the former high.
Better than expected US jobs data and strong German factory orders helped to rally markets Friday. Also, ECB chief Mario Draghi’s Thursday announcement is seen as supporting broad-based asset purchases (QE) early in 2015. A long-term view of major markets may help to place current activity in perspective.
The S&P 500 continues a strong advance, with rising 13-week Twiggs Money Flow indicating medium-term buying pressure. Long-term and medium targets coincide at 2250* and we should expect further resistance at this level.
* Target calculation: 1500 + ( 1500 – 750 ) = 2250; 2050 + ( 2050 – 1850 ) = 2250
CBOE Volatility Index (VIX) continues to indicate low risk typical of a bull market.
Germany’s DAX broke resistance at its earlier high of 10000, suggesting a further advance. Recovery of 13-week Twiggs Momentum above zero indicates continuation of the up-trend. The long-term target is 12500*, though I cannot see this being reached until tensions in Eastern Europe are resolved.
* Target calculation: 7500 + ( 7500 – 2500 ) = 12500
The Footsie is testing long-term resistance at 6900/7000. Respect of the zero line by 13-Week Twiggs Money Flow indicates long-term buying pressure. Breakout above 7000 would signal a fresh primary advance, with a long-term target of 10500*.
* Target calculation: 7000 + ( 7000 – 3500 ) = 10500
China’s Shanghai Composite Index broke resistance at 2500 and is likely to test the 2009 high at 3500. Rising 13-week Twiggs Money Flow indicates strong (medium-term) buying pressure.
Japan’s Nikkei 225 Index is testing resistance at its 2007 high of 18000. 13-Week Twiggs Money Flow respecting the zero line indicates long-term buying pressure. Breakout would signal another primary advance. A long-term target of 28000* seems unachievable unless one factors in rising inflation and continued devaluation of the yen.
* Target calculation: 18000 + ( 18000 – 8000 ) = 28000
Weak ASX 200 performance is highlighted by the distance below its 2007 high of 6850. Falling commodity prices have retarded the recovery and are likely to continue for some time ahead.
The 2005-2008 Australian commodities boom was squandered, damaging local industry and hampering the current recovery. Norway successfully weathered a similar commodities boom in the 1990s, protecting local industry while establishing a sovereign wealth fund that is the envy of its peers. Their fiscal discipline set a precedent which should be followed by any resource-rich country looking to navigate a sustainable path through a commodities boom and avoid the dreaded “Dutch Disease”.
Respect of support at 5000 would indicate the primary up-trend is intact — but declining 13-week Twiggs Money Flow indicates selling pressure. Reversal of TMF below zero or breach of support at 5000/5150 would warn of a down-trend.
* Target calculation: 5000 + ( 5000 – 4000 ) = 6000
The daily chart shows a slightly improved perspective. 21-Day Twiggs Money Flow oscillating around zero signals indecision. Recovery above 5400 would suggest the correction is over. But reversal below 5200 is as likely and would warn of a test of primary support at 5120/5150.
Charles Schwab’s Liz Ann Sonders offers some simple maths that puts it all into perspective. In three sentences:
Consumer spending represents 68% of the US economy. Oil and gas capex represents about 1% of US GDP and less than 9% of US total capex (which in turn represents about 12% of US GDP). Therefore, the benefit of lower energy prices to the consumer and many businesses greatly outweighs the significant hit to energy companies and/or energy-oriented capex, especially in energy-oriented states.
Read more at A 3-Sentence Explanation Of What Crashing Oil Prices Mean For America | Business Insider.
“The current fall in price does nothing to offset the squeeze on the total economy from rising costs,” Grantham writes. “It merely transfers massive amounts of income from one subgroup (oil producers) to another (oil consumers), in a largely zero-sum game….”[Business Insider]
The above quote from Jeremy Grantham made me do a double-take. His “largely zero-sum game” refers to the global playing field. Oil producers such as the Saudis, Russia, Venezuela, Nigeria and Iran will earn less per barrel, while oil consumers like China and the EU will gain an equivalent amount per barrel. More importantly, oil consumers will receive a substantial boost to their economies. The “zero-sum game” assumes that crude production will remain constant. But consumption is likely to rise significantly as plunging oil prices deliver more savings to consumers, providing a massive stimulus to local economies. That in turn will lead to increased production of crude oil. A win-win for producers and consumers.
The Nymex Light Crude monthly chart shows a breach of long-term support at $75/barrel. Brent crude is in a similar down-trend. Target for the (WTI) decline is $40/barrel*.
* Target calculation: 75 – ( 110 – 75 ) = 40
Plunging prices may slow the establishment of new wells, but existing wells are likely to continue pumping as long as the price per barrel of crude is higher than the marginal cost. Marginal costs ignore sunk (or fixed) costs like exploration and establishing a new well. They are merely the variable costs that would be saved — like wages and consumables — if production is halted. Marginal costs are far lower than the producers’ total cost and are not yet threatened.
As for the long-term viability of producers at lower prices, the following chart is worth repeating. Prior to the 2005 “China boom”, the ratio of crude prices to CPI oscillated between 0.1 and 0.2. Over the last few years it has soared to between 0.4 and 0.6. A fall back to 0.2 would harm new, marginal producers (i.e. US fracking) but should not affect core producers. Whether governments reliant on “oil-welfare” — like Russia, Iran and Venezuela — are sustainable is an entirely different matter.
Stock markets in Western Europe and Asia are rallying on the strength of falling oil prices, joining the US in a bull trend. But primary producers, largely dependent on commodity exports, are likely to suffer as a result of falling prices. Australia is no exception.
The S&P 500 continues a primary advance. A conservative target would be 2200*. Rising 13-week Twiggs Money Flow indicates medium-term buying support. Reversal below 2000 is unlikely, but would warn of another correction.
* Target calculation: 2000 + ( 2000 – 1800 ) = 2200
CBOE Volatility Index (VIX) indicates low risk typical of a bull market.
Germany’s DAX is testing resistance at its earlier high of 10000. Recovery of 13-week Twiggs Money Flow above the declining trendline suggests medium-term buying pressure. Breakout above resistance would offer a conservative target of 11000*. Reversal below 9000 is unlikely, but would warn of a primary down-trend.
* Target calculation: 10000 + ( 10000 – 9000 ) = 11000
The Footsie is also testing long-term resistance on the monthly chart — at 6900/7000. The sharp rise on 13-Week Twiggs Money Flow indicates strong medium-term buying pressure, but resistance at the December 1999 high is likely to be solid. Reversal below 6500 remains unlikely.
China’s Shanghai Composite Index cleared resistance at 2440/2500, signaling a primary up-trend. 13-Week Twiggs Money Flow respect of its rising trendline confirms (medium-term) buying pressure. I remain wary of China. The recent rate-cut by the PBOC is cause for concern, not jubilation.
* Target calculation: 2500 + ( 2500 – 2000 ) = 3000
Japan’s Nikkei 225 Index is headed for long-term resistance at 18000. 13-Week Twiggs Money Flow oscillating above the zero line indicates long-term buying pressure. Reversal below 16500 is unlikely.
* Target calculation: 16000 + ( 16000 – 14000 ) = 18000
The ASX 200 is undergoing another correction. Respect of support at 5250/5300 would indicate the primary up-trend is intact — but 13-week Twiggs Money Flow reversal below zero warns of strong selling pressure. Breach of support is likely and would warn of a test of 5000.
* Target calculation: 5650 + ( 5650 – 5300 ) = 6000
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