GU 15Jan16Oil markets finally entered their “give-up phase” last week.  Amazingly, it is now nearly 18 months since the start of the Great Unwinding of policymaker stimulus in August 2014, when Brent was still $105/bbl.  On Friday night Brent closed at $29/bbl.  As ICIS Chemical Business (ICB) notes in its latest editorial:

International eChem’s Paul Hodges has been predicting $20-30/ bbl since August 2014 and he has now been joined by the likes of Goldman Sachs and Morgan Stanley in expecting the rout to continue and low prices to persist for years”.

Until last week, virtually all the analysts were still insisting that oil prices would return to at least $50/bbl, or even $100/bbl.  In their view, it was just a matter of “when”, not “if”.  But now, they have finally begin to face reality, as I discussed with ICB:

It’s a market share game, as the Saudis realised when they gave up trying to hold the price 18 months ago. You either sell today, or risk ending up leaving the oil in the ground.”

The chart of the Great Unwinding above shows how far we have travelled before this simple truth was finally recognised:

  • Brent oil prices are now down 71%, and fell 13% last week
  • The US$ is up 21%, having broken out of its 30-year downtrend

And more recently, of course, the other elements of the Great Unwinding have begun to impact – European and Japanese equity markets are down 10% since the start of the year, and US markets are down 9%.  As US financial magazine Barron’s notes:

“The juice that the Federal Reserve had provided is being withdrawn, and the symptoms of going off the stuff are becoming apparent. The U.S. stock market is off to its worst start of any year on record.”

OIL MARKETS ARE NOW IN THE GIVE-UP PHASE
What happens next is obviously the key question.  I have never know a major price movement, of the kind we’ve seen with oil over the past 18 months, end without an overshoot.  It therefore seems very unlikely that it could suddenly stabilise at $25/bbl, although I do expect this to return to being the long-term level

  • Supply/demand factors suggest there is still a major imbalance in the market
    • The IEA says there are a record 3bn barrels of storage
    • The US has record storage, and European storage is virtually full
    • China has become a net exporter of oil products as its economy slows
    • The mild Western winter has reduced demand for heating purposes
  • 2 major exporters are now re-joining the market:
    • Iran is expected to add up to 500kb/d in January now nuclear sanctions have ended, and has said its production costs are $1.70/bbl.  It wants to regain lost market share as quickly as possible
    • The US has just begun shipments.  Given its high storage levels, it would make sense to monetise these quickly via sales, especially as they are costing money to store
  • The short-term outlook is weak, given that Chinese/Asian demand is now slowing ahead of Lunar New Year on February 8, and March will see the traditional maintenance season for Western refineries after the winter
  • US production costs are falling fast, with Daniel Yergin suggesting that a dollar spent in December was “65% more efficient that a dollar spent in 2014
  • The outbreak of tension between Saudi Arabia and Iran makes it most unlikely that OPEC could agree to any major cuts in production, even if Saudi wanted to change course

Companies and investors therefore need to prepare for further chaos ahead.  I fear that oil producers and oil consumers will now start to go bankrupt – producers because they cannot pay their interest bills, and consumers because they have high and expensive stock levels.  Many consumers put their trust in the so-called “experts”, and rushed to fill tanks and warehouses in November/December, assuming that prices would rise in January.

Today, however, buyers all down the chain are in a state of simple panic, and worry that making any purchase is like trying to “catch a falling knife”.  As I have long feared, we face a very difficult 2016.

WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments: 
Brent crude oil, down 71%
Naphtha Europe, down 66%. “Fundamentals weaken on US gasoline build”
Benzene Europe, down 59%. “Tumbling crude oil and benzene numbers are weighing down on the European styrene spot market this week, with talk of strong derivative demand doing little to stem the downward movement.”
PTA China, down 46%. “Downstream polyester producers have confirmed turnaround plans and adjusted contractual volumes for the Lunar New Year holidays, sources in the country said. They also have sufficient inventories to last them until after the long holiday”
HDPE US export, down 41%. “Prices have to come down because there is too much North American supply already and more capacity coming on line throughout 2016”
¥:$, down 15%
S&P 500 stock market index, down 4%