By David Haggith, The Great Recession Blog
The perfect storm I predicted against the price of oil in the Ides of March has not fully developed, but all the forces I spoke of are continuing to build. The balmy days that prevailed for oil prices in early March have gone away, replaced by a downdraft that is once again suppressing prices more and more since their peak in mid-March. The storm’s breezes can now be felt in prices that have relinquished 40% of their earlier gains, and the clouds are becoming more apparent to all.
Prices had one of their worst days of the year on Friday of last week and drifted marginally lower again on Monday of this week, stabilizing some on Tuesday. Friday’s pounding came because Saudi Arabia announced it would not participate in the oil supply freeze that it negotiated with Russia since Iran is not going to join the freeze.
That is one of the major storm fronts that I said would come into prominence as part of the perfect storm against the price of oil. I pointed out a few times that market enthusiasm over talk of a deal (still not completed) between Saudi Arabia and Russia to merely freeze production was ludicrous because the Saudis always said the deal was contingent upon other producers joining and that “other producers” most certainly included Iran, and that Iran most certainly would not join the deal.
Don’t expect Saudi Arabia to flinch and start backing down now that Iran has made clear it will not join the deal by freezing its production. Deputy Crown Prince …
Bin Salman nevertheless said Saudi Arabia was ready to face a prolonged period of low oil prices that have dropped sharply since mid-2014 as a result of higher global production. “I don’t believe that the decline in oil prices poses a threat to us,” he said. (Arab Times Online)
Even if a production freeze is formalized, it’s a bad thing, not a good thing. That makes it all the more silly that talk of the deal pushed down prices for awhile. The deal, if it happens, promises to freeze production at January’s extremely high levels, which absolutely guarantees continued oversupply (unless there is a huge increase in demand, which so far has evaded the oil industry). A freeze is far from being a production cut, which is the only thing that can solve the oil industry’s problems on the supply side. Far too much as been made of the deal by a market full of unrealistic optimists for that reason.
Freezing production at January levels is “looking more and more pointless”, according to analysts…. What is becoming very clear is that Saudi Arabia is serious about moving away from the traditional play of adjusting prices by cutting or freezing supplies by itself. (The Week)
The dividing line between Saudi Arabia and Iran has hardened, and a deal would only freeze production at a level of continuous oversupply. All what I said a month ago. It’s a deal that is not likely to happen, and if it does, it is pointless anyway. I’ve just been waiting for this one part of the storm to organize into clear formation so that everyone can see it before writing more, and it now has. You can see those swirling storm clouds from that particular direction quite clearly now in the daily news, and you can see that they have started bringing down oil prices.
That was Friday’s big blow. Monday’s downdraft came in part because the National Iranian Oil Co. stated that it just authorized sales of crude to Dutch Royal Shell after the company settled a debt dispute with Iran. Iran repeated that it will continue to expand its oil production and sales until they reach the levels they were before Iran’s nuclear dispute with the West, hardening its stance against the Saudi-Russian deal.
Demand for Oil Products May be Receding, Not Rising
Compounding matters, government data was released on Monday that showed the first small drop in gasoline demand in fourteen months. Until now, gasoline demand has remained a pillar that helped support the US oil industry through the supply glut. Drop in demand for products derived from oil is being noted in other parts of the world, too:
The oil price “can easily revisit the lows seen earlier this year,” French bank BNP Paribas said in a note to clients, as bearish demand data added to concern over a deal to freeze excess supply…. This comes ahead of a second quarter period that typically sees a dip in demand as refinery maintenance peaks. (The Week)
That’s right. The refinery shut-down period for maintenance that I said would be the second front that comes in to form the perfect storm has just begun. It’s a couple of weeks later than I expected, but wind from that direction is picking up velocity now. It will become an additional force against the price of oil so long as refineries stay in maintenance mode, which reduces their demand for crude.
The Third Front in the Perfect Storm — Tanks Starting to Fill to the Brim
…This all coincides with figures showing buying of crude derivative products slipping in key Asian markets, “as onshore storage facilities in Singapore and Malaysia are filled to the rims”
The third front is just starting to happen. It will very slowly gain strength, but it certain to be the worst front of all over time. As tank farms around the world fill to capacity along with ships at sea, storage becomes more problematic. Oil has fewer and fewer places to go, and demand for crude will fall off a cliff.
As it stands right now, there is nothing that will prevent that from happening. A production freeze means we keep moving toward that end at the current rate of production. Lack of a freeze means production continues to expand so that the world has to make the necessary supply adjustments out sooner.
On Tuesday, Brent crude briefly touched down on a one-month low of $37.27 then floated back up slightly when Kuwait claimed that a production freeze is still possible without Iran.
Asked if anything is likely to come from the April 17th meeting of OPEC where the possible production freeze will be discussed, Lord John Brown, executive chair of L1 Energy, told CNBC:
I’d be very surprised at this time. Production is high. People are scrambling to maintain markets that they have and to gain markets from other people. So, it’s not a time for reconciliation yet.
I would be surprised, too, because Kuwait doesn’t have a lot to say about it and, in fact, is doing its part to make things worse, while Saudi Arabia has made its position clear, exactly where I said it would stand. In fact, Kuwait may just be trying to take pressure off its own announcement that it will be ramping up more production soon:
The Middle East sour crude complex is likely to come under bearish pressure on news of Kuwait and Saudi Arabia agreeing to restart production from the 300,000 b/d offshore Khafji oil field…. “Even the idea of a freeze [in oil production] may be tested by [the] announcement that Saudi Arabia and Kuwait are preparing to restart the 300,000 b/d Khafji oil field … Citi analyst Timothy Evans said in a note to clients. (Platts)
Iraq’s oil production also increased through the month of March.
The impact on the US oil industry, seen in broad terms, is that the US now has fewer oil rigs in production than at any time in the past sixty years following fifteen weeks of continual decline. Nevertheless, oversupply continues to rule the market. As many as sixty small and a couple of large oil companies have gone out of business or declared bankruptcy.
Numerous bonds and other forms of loans to the oil industry are in default but are being ignored by banks because the banks don’t wish to compound the problem for themselves by creating a situation where they have to write down the value of the securities on that debt and have to write of debts. So, everyone is trying to sit it out. The scale of the problem for banks is largely masked because the Dallas Fed has told banks to sit tight as much as possible.
It’s believed data later this week will show that crude stock in the US has continued to grow over the past week to a higher record high. That will be the eighth week of setting new records in total US oil storage. If that data turns out as expected, that will offset news of a drawdown in Oklahoma the week before, showing it that to be nothing more than a brief eddy in the winds.
We are relentlessly getting closer to a point of total market saturation, which happens when all tanks are full.
Conclusion: The perfect Storm for Oil is Arriving Onshore Now
The winds and clouds that are bringing the perfect storm against oil prices from three fronts are all growing stronger. I can now easily find many conservative market analysts starting to agree with what I predicted a month ago:
Commodities including oil and copper are at risk of steep declines as recent advances aren’t fully grounded in improved fundamentals, according to Barclays Plc, which warned that prices may tumble as investors rush for the exits…. “Given that recent price appreciation does not seem to be very well founded in improving fundamentals, and that upward trends may prove difficult to sustain, the risk is growing that any setback will result in a rush for the exits that could again lead commodity prices to overshoot to the downside.” (NewsMax)
“Overshooting” is just another way of saying “the perfect storm.”
Barclays also notes that positioning in the oil market has reached “bullish extremes” because the bullish rise in crude oil prices is not based on sound fundamentals. That’s right. It’s based on wishful thinking that is based on vague hopes that, if properly worded, would say Saudi Arabia will continue its production full speed ahead if Iran does cooperate and will otherwise increase production beyond its current levels. (That’s all a production freeze offers.)
Barclays says the rush for the exits could bring a price drop of 25%.
Even Goldman Sachs agrees with me now:
Energy needs lower prices to maintain financial stress to finish the rebalancing process; otherwise, an oil price rally will prove self-defeating as it did last spring. (Zero Hedge)
In other words, this problem is NOT going away until lower prices finish the job of flushing away the weakest competitors as a way of reducing supply to match current demand. So, if the energy production deal does finally go through in mid-April, we will still have to fill our waterbeds with oil to find places to store the overproduction. It will just take longer to get to the point. (The greater truth is that Saudi Arabia and Russia cannot really ramp up oil production much more anyway. So, talk of a deal not to increase production is really the most meaningless babble on the planet right now.)
Whether a deal happens or not, more oil companies, more related service businesses, and some of their bankers will be flushed away. The only thing that could change that is either a big increase in demand (not seen as likely by anyone that I’ve come across) or a big reduction in supply (not being talked about by anyone anywhere).
Barring a war or huge natural catastrophe that forcibly cuts off large amounts of production, the only reductions in supply that will happen are the hard ones that come from businesses closing shop. Those who continue to hope for an easier answer in the form of prices that stabilize the market at its present production levels are nothing but rosy-eyed dreamers, living in economic denial.
The statements, views, and opinions expressed in this article are solely those of the author and do not necessarily represent those of EMerging Equity.