In a week that started with big oil and US shale producers trumpeting their ability to thrive in a world of $50 a barrel crude, the market had a very quick response: let’s see if you can do it at $45.
A brutal sell-off across commodity markets this week has quickly taken the shine off strong first-quarter results that would otherwise have been viewed as a triumph for the oil industry’s ability to adapt to lower prices.
Instead, the industry is staring at the threat posed by the latest price drop and questioning whether another leg lower beckons.
Opec and other big producers bailed out the market with supply cuts in the first quarter of 2017, allowing crude to recover above $50 a barrel and stoking hopes of a brighter future, not least among funds that placed record bets on oil’s recovery.
But persistently high oil stockpiles and growing evidence of the industry’s ability to keep pumping at relatively low prices has eroded confidence in a sustained rebound.
The pressure on oil comes when commodities from iron ore to copper have also slumped as investors fret about demand in China, where policymakers are attempting to tackle a huge credit bubble. The spot Bloomberg Commodity index, a basket of 22 futures contracts, fell to a five-month low on Friday as anxiety grows over China, the world’s biggest importer of raw materials.
While Opec is expected to extend supply cuts when it meets this month, there appears, at this point, to be little appetite or ability to do more. The last agreement took months of shuttle diplomacy to piece together, and members’ cohesiveness will not be helped by the drop in prices.
“Today, Saudi Arabia and many other Opec countries have lower oil revenues than a year ago,” says Olivier Jakob, analyst at Petromatrix in Zug, Switzerland, arguing they have cut volume for little price benefit.
“If oil prices do not quickly rebound there is a risk to see the start of a blame game.”
Goldman Sachs noted on Friday that while it still believes prices will recover in the second half of this year, with most forecasts still pointing to a slow drawdown in oil inventories, there was a danger oil is nearing “capitulation”.
Crude contracts for delivery several years in the future have also weakened sharply this week, with fewer investors willing to bet on future supply shortages now that shale producers have demonstrated they can raise output at lower prices.
“The most noteworthy move in oil prices over the past week and past year in our view remains the steady decline in long-term oil prices,” say Goldman analysts.
Brent for delivery in December 2020 dropped to just above $50 a barrel on Friday morning from above $60 a barrel just seven months ago. Energy is now the worst-performing sector on the S&P 500 in 2017 having been the biggest winner last year.
The sell-off in oil and other key commodities has also coincided with recent weak manufacturing surveys in China. Over the week, copper fell 4 per cent to $5,555 a tonne, nickel 5 per cent to $9,000 and iron ore — a key ingredient in steelmaking — 12 per cent to below $60 a tonne for the first time in six months.
China’s central bank has been draining cash from its banking system as part of an effort to tame financial risks by squeezing liquidity. The impact of tighter credit conditions is already starting to be felt with Chinese companies cancelling bond and short debt issuance.
“Chinese economic data, while not yet bearish, is in danger of topping,” note analysts at Barclays. “The collapse in steel prices that preceded the copper and iron ore sell-off was an early sign that the metals sectors of the Chinese economy were showing signs of a slowdown.”
The same hedge funds that had been betting on a recovery in oil might now hold clues to how big the sell-off could become. Earlier this year they had amassed a record net position of almost 1bn barrels of crude, which has been getting unwound.
“As we have entered a capitulation phase it is not the price but the size of the position held by those needing to reduce that will determine where we go from here,” says Ole Hansen at Saxo Bank, adding some funds may be tempted to buy back in.
“Two high-volume days are likely to have created a bigger balance between long and short positions.”
Late on Friday crude started to rebound, with Brent up 2 per cent on the day to $49.33 a barrel — a near $3 rally off its low of $46.64 a barrel hit earlier in the session.
Fidelity’s Kevin O’Nolan, who invests directly in crude oil as part of his management of nearly $600m in the company’s Multi Asset Allocator range of funds, argued that the extent of the sell-off was perhaps over done.
“There’s been a loss of patience in the rebalancing of the market then some technical elements laid on top of that,” Mr O’Nolan said.
“You’re about to come into a more seasonally positive period for oil demand and Opec production is down by more than the rebound in US production. These kind of prices are just not enough to sustain investment in the longer-term.”
Opec, analysts say, may still need to ride the latest drop and maintain the cartel’s commitment to supply management if it is to have any chance of the price edging back up.
“After the recent disappointments market participants are likely to require more than a few soothing comments,” say analysts at JBC Energy. “In other words, hard facts in terms of more meaningful stockdraws would be needed.”
With reporting by Anjli Raval and Henry Sanderson
