Fundamental Analysis of Crude Oil Sector:
Market participants are of the view that OPEC-sponsored November talks, a plan proposing production cuts between 32.5 and 33 million barrels’ crude oil production on its 14 member groups, can come undone for tangible reasons. Firstly, because both Iran and Iraq, which account for 25% of OPEC crude oil production, are refusing to freeze output what to speak of curtailing production. Further data from EIA, has revealed growth in domestic production as oil-rig counts have increased in the past months. As seasonal slowdown is on the horizon, given that Saudi Arabian production tends to slow down during this time of the year, coupled with the fact that WTI prices hovering 30% higher than the start of the year, there is a fear factor of losing market share but also a price crash. To avoid this happening to non-OPEC members it is important that the market should act in concord and it is due to this Saudi’s are spearheading this call for acting in unity. Analysts have been of the view that a case for a cut is really a cover for an event which was bound to happen anyway, noting that is really a cover for maintaining market share and it has been realized that a price warfare is not good for the market collectively. A production cut does come with encumbrances that will not be shared by member states equally given that the less affluent member states would not have the necessary revenue buffers to withstand further the impact of lost sales. Contrastingly Saudi Arabia has developed an $18 billion buffer from the bonds market to withstand a loss if the deal were to go through. It is worth mentioning that the kingdoms 2014 decision to double up the production in a drive to maintain market share, has made it difficult for their higher cost producers to thrive as they once had and this is not only limited to OPEC members but also for their Cross-Atlantic market participants. With the possibility of a price meltdown, EIA reports that the amount of WTI short positions are almost at a decade high, which really defines the sentiment of the market and is just could be a precursor for a sudden drop. At least the technical picture seems to suggest that as the market has retraced back to the 23.6% Fibonacci level and a 38.6% Fibonacci level, corresponding to a $60 price, is still probable but if only viewed the scenario highly optimistically.
The expected continued strength of the US dollar index, which has maintained a negative correlation with crude oil prices, will also continue to exert pressure given FED’s stance to normalize interest rates with an expected raise of at least 25 basis points to come within 2016. The next FED meeting, set for Nov 2nd, 2016, could be a dollar moving event, but it must be borne to mind that previous rate hikes had been factored into price movement well in advance; would this one be different? And from a term structure standpoint, as the spread between short-term and long-term treasury yield falls, and further also viewed purely technically, room for drastic appreciations aren’t really in the offing. But that is surely the long term and not the immediate forecast as the US$ preservers with its show of strength continuously casting dark clouds of an oil rebound at least not till the end of 2017. And yet the other factor to add to the volatility is the outcome of the election day on November 8th. Donald Trump and Hillary Clinton have opposing stances, with the Republican nominee poised to make US energy independent by removing drilling restrictions on federal lands while Clinton plans to make the country into a clean energy superpower. Market analysts are of the view that Clinton’s approach is well priced into the market, and while Trumps is not, it could be a source of increased volatility.
Structurally seen, with seasonal demand reaching a soft point, and crude oil at best being in a corrective state means that stormy weather lies ahead. Surely from this standpoint, the greenback is set to gain amidst all this tumult in the horizon as the market tries to re-adjust to a new equilibrium.