What Should We Conclude From This Recent Bounce In Crude Oil Prices?
$OIL, $USO
Crude Oil prices have bounced off of their August lows, tapping at the Key resistance of 50 bbl Thursday.
The Big Q: What does this mean in the overall picture?
The news influenced Thursday’s action.
- The Federal Reserve released the minutes of the September FOMC session, and these conveyed continued worries about global growth and reservations about near term interest-rate increases. The markets cheered the Bad News, and both equities and Crude Oil prices rallied.
- The Shanghai Composite Index jumped by 3% Thursday, easing fears of a downturn there. For Crude Oil, this is of Key importance. Despite talk of slowing GDP growth, Crude Oil demand is very strong.
According to China Oil, Gas & Petrochemicals, China’s gasoline and jet-fuel demand were both up more than 20% in July from a year earlier, and Crude demand was up more than 6%. At the same time, the China Association of Automobile Manufacturers reports auto sales for August fell by 3.4% Y-Y.
Are we to conclude that China has a strong and solid economy as it and the IMF says, or is it sliding into some kind of recession like the Fed alludes to and the US pundits herald?
This Summer’s sell-off of Chinese equities alarmed global investors about the country’s economic prospects. By contrast, emerging stability in Chinese stock indices and Friday’s rally argue that China’s economy is not as weak as feared. And that the correction was normal in its raging Bull Market.
Over the last few years, the US Crude Oil trade deficit has declined, as a result of both surging shale Oil production, and from mid-2014, a collapse in Crude Oil prices.
This has dramatically improved US terms and trade and led to a re-valuation of the USD Vs its trading peers, that is, all but China.
With the exception of a small adjustment last month, Chinese monetary authorities have declined to devalue the Yuan in line with the JPY, WON or WUR. As a result, China’s export sector has found itself at a competitive disadvantage and suffered. So, in this case we expect to see China’s consumer sector strong and its manufacturing and export sectors weak.
But, attribute the US currency run-up to rising shale Oil production, then the USD has likely peaked. US Crude Oil production is falling, and consumption continues to be strong.
So, US Crude Oill imports were up over the last 3 months. With this, the US Crude Oil trade deficit will begin to increase in both volume and unit price. If we believe shale Oil is behind the USD’s appreciation, then a reduction in shale Oil production and an increase in Crude Oll prices will devalue the USD.
The beneficiary of this a devaluation is China, because it has steadfastly pegged the RMB Yuan to the USD. So, if China’s problem is linked to an over-valued currency, re-balancing Crude Oil markets will come to the rescue, and confidence in China’s outlook will return.
For Crude Oil markets, China’s path is critical.
If China were to enter a downturn along the lines of the Asian financial crisis of Y 1998 (not likely), the swing in net Crude Oil demand in Y 2016 could be 1-M BPD+, The re-balancing of Crude Oil markets could be delayed by 6 to 18 months, depending on the scenario. For US independent producers the effects will be very painful.
My work shows a upward supply revisions, and therefore balances may prove less favorable to price increases than currently seen by some analysts, as they are not taking into consideration that there are 2.4-M BPD in oversupply now, and Iraq is set to produce more, plus the fact that Iran will come to market with millions of stored and new barrels when the sanctions are lifted in Q-1 of Y 2016.
In that scenario, no matter how strong China and the US demand recovery prices will continue in their current downtrend and head to the lows of Y 1998 at 22 bbl, and possibly lower..
For suffering Crude Oil investors, the worst is yet to come, as the re-balancing that people are talking about now is a long way off.
My bias is Neutral near term to Bearish-Very Bearish long term.
Have a terrific weekend.
Paul Ebeling
HeffX-LTN
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