In recent years, financial markets have believed that “everything is for the best in this best of all possible worlds“. Good news has taken markets higher. So has bad news – as investors assume policymakers will apply more stimulus.
As a result, a whole generation of managers and analysts has grown up without having to learn the fundamentals of supply/demand analysis. And many of those in the older generation have gone bankrupt, as a result of failing to understand that central bank liquidity has destroyed markets’ prime role of price discovery.
But now the Great Unwinding of these central bank policies is underway. And last week’s developments in oil markets provided a classic example of the bumpy ride now ahead, as investors adjust to the world of the New Normal.
1. Saudi reaffirmed its market share policy. Last weekend saw a clear statement by Saudi Arabia’s Oil Minister, Ali al-Naimi, that the Kingdom did not intend to cut production to support oil prices. Announcing that production had increased to around 10mb/d, Naimi added:
“Saudi Arabia cut output in 1980s to support prices. I was responsible for production at Aramco at that time, and I saw how prices fell, so we lost on output and on prices at the same time. We learned from that mistake.”
2. China has run out of oil storage. On Wednesday morning, Sinopec told Reuters that:
“China’s commercial and strategic oil storage is almost full, leaving little room for Asia’s top oil consumer to keep up its soaring import growth and adding downward pressure to an already oversupplied market. China’s purchases to fill its strategic petroleum reserves was one of the main drivers of Asian demand since August of last year, with the nation’s importers buying cheap crude to fill oil tanks despite slowing economic growth. But with storage capacities approaching their limits, China’s crude imports will likely stay flat or rise only slightly this year.
3. US oil inventories at new record high. On Wednesday afternoon, Reuters also reported that:
“U.S. crude inventories soared last week to extend their record build into the eleventh consecutive week. Crude inventories rose 8.2 million barrels to 466.7 million last week, another 80-year high record, compared with analysts’ expectations for an increase of 5.1 million barrels.”
Yet on Thursday, as the chart shows, Brent prices suddenly soared by $4/bbl as Saudi launched air strikes into the Yemen. Excited analysts rushed to suggest this created a “geo-strategic premium” for prices and could mean the end of Middle East oil shipments. This reaction highlighted the consensus view that prices will always trend higher.
Interestingly, however, Friday’s trading saw prices fall back to their starting point.
The move thus confirms my fear that the world has a very bumpy ride ahead. Until very recently, as the above chart shows, hedge funds have also consistently assumed that oil prices will always rise (red line). This positioning has continued since 2006, even during the collapse of H2 2008.
US oil producers have taken the same view, with the Wall Street Journal suggesting many are effectively storing oil today by drilling thousands of wells in anticipation of higher prices, but not yet pumping from them.
The hedge fund logic has been simple, that it makes sense to ‘buy on the dips’. But more recently, however, there are signs their thinking is finally changing. More hedge funds are now negative on prices than ever before (green shading). Last Thursday’s abortive rally may well cause more to rethink their positions in the future.
WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Benzene Europe, down 52%. “Sources are wary of crude oil pricing going forward, with building stocks in both Asia and the US likely to spark a sell-off in the coming weeks, according to some analysts. Any major shifts on crude oil would potentially have a massive impact on benzene pricing.”
Brent crude oil, down 46%
Naphtha Europe, down 39%. “Summer gasoline blending plus Asian and European petrochemical demand combined with spring refinery maintenance work have tightened prompt supply.”
PTA China, down 40%. “Excess PTA inventories in the key China markets continued to dampen market sentiment, with inventory levels likely to continue to build up in the near term.”
HDPE US export, down 23%. “US export prices remained unchanged this week”
¥:$, down 16%
S&P 500 stock market index, up 5%