FT Explainer: Oil re-enters bear market
Oil re-entered a bear market on Tuesday extending the previous day’s losses, when Brent crude — the international benchmark — recorded its biggest one-day sell-off since February.
After dropping more than 6 per cent on Monday, Brent fell a further 2 per cent in the next trading session to $55.40 a barrel. It is down more than a fifth from its year-high of $69.63 a barrel reached during intraday trading in May.
When prices fall by 20 per cent from their peak, this is commonly defined as a bear market. The renewed sell-off comes a year after the oil market started its descent from above the $100 a barrel level it had averaged for most of this decade.
Here are six reasons Brent and US crude oil futures are falling again.
Iran nuclear deal
Expectations that western powers will strike a nuclear deal with Iran in the coming days has refocused the market on the return of additional exports of Iranian barrels, which have been sharply curbed by sanctions in recent years. While the timeline for lifting sanctions remains unclear, it is estimated that Iran could add up to 800,000 barrels a day to the market within a year.
Additionally, the Opec member is seen holding up to 40m barrels of crude oil and condensate in floating storage that it has been unable to sell because of the sanctions regime. Those barrels could quickly add more short-term pressure to an already oversupplied market.
“We are getting closer to the Iranian deal . . . and we think that the surprise could come from the timing of the lifting of the sanctions,” says Olivier Jakob at Petromatrix.
“Most of the publicised analysis has been about Iran exports not before next year and an earlier restart of Iranian exports to Europe can still come as a surprise.”
China has been the centre of global oil demand growth over the past decade, rising from a bit-part player in the market to overtake the US as the largest importer of crude and refined products in the world. So when China’s economy wobbles, the oil market is quick to respond. Moves by China’s central bank to shore up the economy, including cutting rates and lowering reserves banks must hold, have been interpreted by many oil traders as a sign that growth in the Middle Kingdom is even worse than first feared. Volatility in China’s equity markets has also pushed some market participants to the sidelines.
“Data on the demand side out of China, such as crude oil imports, has been weak lately and has contributed to oversupply fears,” says Carsten Menke, commodities analyst at Julius Baer. “Taken together with falling metal prices, commodity markets are signalling broad-based concerns about Chinese demand and the government’s ability to stimulate growth.”
Greece’s decision to reject the bailout package is unlikely to have a significant immediate effect on oil demand. But it has sparked a bout of risk aversion across markets and led to a strengthening in the US dollar. Commodities like oil that are priced in dollars tend to move inversely to the US currency.
“The evolving situation in Greece will be a factor on all markets for the foreseeable future,” said Dominick Chirichella at the Energy Management Institute in New York.
US shale resilience
The resilience of US shale oil production has impressed many traders. While last year’s near halving in US prices from above $100 a barrel to closer to $50 today has seen growth in the sector stall, so far production has held up in most of the major shale plays. Last week the number of oil rigs drilling in the US rose for the first time in 29 weeks, in a sign some shale companies have successfully squeezed down costs and moved to reposition drilling rigs to the most productive plays. US crude oil inventories also rose last week and are above 465m barrels, a level never recorded before 2015.
“It appears to be economic for producers to increase the number of rigs when WTI is around $60-$65 a barrel,” said Tamas Varga, an analyst at brokerage PVM.
Swelling Opec supplies
Opec’s oil production has also been on the rise, hitting a three-year high in June with output from Saudi Arabia and Iraq close to the highest level on record. The cartel’s output is estimated to be more than 1.5m b/d above its 30m b/d target as members compete for market share. That has contributed to inventory levels in northwestern Europe rising last month to 61m barrels, the highest in at least two years, according to Genscape.
“While the recent vote in Greece and China’s monetary intervention might have been the trigger points we feel the need to point out that fundamentals are certainly driving oil prices lower,” say analysts at JBC Energy in Vienna. “We expect stocks globally to continue building through to the end of this year, making eight successive quarters of implied stock builds.”
Hedge funds cut long positions
The rebound in Brent prices from a six-year low of $45 a barrel in January to $69 in early May was stoked, in part, by near-record hedge fund buying as speculators bet low oil prices would quickly crimp supplies. By May hedge funds were holding futures and options positions equivalent to almost 289m barrels of oil on the Intercontinental Exchange. But since then hedge funds have cut their so-called net long position — the difference between bets on rising and falling prices — by roughly a third to less than 200m barrels.
“Low prices will eventually cure low prices. But we must not get too excited too quickly,” say analysts at consultancy Facts Global Energy in a note. “The structural imbalance created by sustained prices over $100 a barrel was years in the making. It will not be cured overnight.”