Don’t Bet On A High Oil Price Forever
A resolution to the Eurozone crisis continues to get “kicked” down the road, growth in China seems to be flat-lining and the US economy, while it is picking up, can’t be described as firing on all cylinders. Yet the oil price seems to be oblivious to these problems with global growth and has managed to appreciate nearly 30% since the middle of June. But is this sustainable and should oil traders prepare themselves for a sell-off?
To answer this we need to analyse what have been the main drivers behind the move higher in the oil price that started two months ago. Firstly, there may have been a technical reason for the bounce. When it fell below USD 90 back in June some technical indicators were starting to look oversold. Essentially this means that when a price falls to a certain level, in this case 30% from its March 2012 high, the selling interest starts to wane and people get interested in buying again at a cheaper price. This may have accounted for some of the bounce in June.
The next reason is that the Eurozone debt crisis has shown signs of stabilising. Although the same debt mountain is still there and interest rates for Spain and Italy are above their historical average, recently there have been more frequent signs that the Eurozone authorities will step in to try and calm the situation in the currency bloc when the situation gets critical. This helps “riskier” assets like oil to rise as it helps calm investors’ nerves.
Thirdly, sanctions on Iranian oil shipments are also considered one of the reasons why the oil price is rising. Some worry that this could cause supply disruption. By essentially banning large swathes of the world from importing Iranian oil, the US and European authorities have caused a contraction of supply. If there is a problem with supply elsewhere in the world then these actions could start to impact the price of oil. However, investors and global oil purchasers had six months to prepare before the sanctions came into play, thus it’s hard to blame the Iranian issue on the spike higher in the oil price.
More important in my view, and the fourth reason for the upswing in the oil price has nothing to do with supply and demand, well not that much to do with supply and demand, anyway. It has to do with expectations that central banks will pump the global economy full of excess liquidity in the form of quantitative easing and monetary stimulus. When an economy looks like it suffering central bankers can try and artificially boost growth by pumping cheap money into the economy.
This works a bit like cheap credit in the West, whereby if you are given money at a favourable rate you will choose to invest it/ spend it for a profit and then pay it back later. There is a similar principle behind QE. However, sometimes people don’t want to invest, even if money is cheap. That is what we have seen during the last two rounds of QE from the US central bank the Federal Reserve. Instead this money seeps into the wider economy and people play the financial markets with it. Hence the oil price tends to rally on the prospect of more QE.
However, this time round the markets may have been too hasty and the prospect of more QE is not as clear-cut as it was back in 2009, 2010 and even 2011. The US economy is doing just about well enough to make it hard to justify more QE, added to that the Federal Reserve tends to be fairly muted in an election year. In China the government is concerned about adding more stimuli in case it stokes inflation or banks to go on a lending spree that leads to bust property bubbles and a rising bad loan ratio. In Europe the ECB seems to only do too little too late, so the oil price bulls out there shouldn’t bet on global central bankers coming to the rescue and fuelling another leg higher in crude prices.
This has left some people thinking that oil is due a big sell-off. There are some who think that Brent crude oil price’s failure to convincingly stay above USD 115 a barrel in the last two years is a sign that a sell-off is nigh. Others believe that the market has never really recovered from the 2008 sell-off, when Brent crude plunged to below USD 40 per barrel. They believe that the recovery of the last four years has been a bear-market rally and is at risk of crashing off.
That didn’t stop the Energy Information Administration in the US from raising its estimate for the price of crude oil this year from USD 106 per barrel to just over USD 108. Either way that would spell a decline for those who bought oil at the start of 2012, currently the average price is USD 111 per barrel for Brent crude, if the EIA is correct then there could be further weakness in the near term.
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Zawya
