Crude convulses in the grip of economic uncertainties

Fresh reminders of the global glut – the International Energy Agency (IEA) pegged second-quarter supply-demand mismatch at 3 million barrels per day – and a worsening outlook on China’s economy with its potential ripple effects in the region and beyond drove global crude benchmarks to six-and-a-half-year lows. 

On August 24, front-month Brent futures plummeted 6 per cent in a single day to close at US$42.69 (Bt1,534)/barrel, while NYMEX light sweet crude slipped 5.5 per cent to $38.24, spooked by an 8.5-per-cent plunge in China’s Shanghai Composite Index, which sent shock waves across equity markets worldwide. 

Crude ticked up in fits and starts in the following days, but Brent still closed the month 20 per cent below its year-to-date high of $67.77. Alarm bells were already ringing on Beijing’s move on August 11 to devalue the yuan and the subsequent government interventions to manage the currency’s descent while trying to contain the domestic stock-market rout at the same time.

Poor economic data, showing more pronounced contraction in manufacturing activity and a slump in Chinese exports, reinforced a more pessimistic prognosis for the world’s second-largest economy.

China is expected to continue ratcheting up its crude imports between 2015 and 2020 at an average rate of about 5.5 per cent, importing roughly 210,000 b/d for stockpiling over this period, while its oil demand grows at just around 3.6 per cent annually, according to a recent report by Platts China Oil Analytics. The market is not oblivious to the pockets of demand growth across the globe, prominently in China and the US, but it is also painfully aware of the gulf between incremental consumption and the rising tide of supply this year and the additional barrels expected from a post-sanctions Iran in 2016.

The IEA in its August report pegged this year’s oversupply at an average 1.1 million b/d, saying it expected demand to increase by 1.6 million b/d (in contrast to just 700,000 in 2014) and supply to rise by 2.7 million b/d.

What the August price rout tells us is that market participants are far less sanguine about the demand-growth story in the face of economic headwinds, including those in Europe. Expectations of supply overhang now extend beyond 2016, and NYMEX crude is below the $55 mark on the forward curve through the end of next year. 

In the meantime, production from Opec (Organisation of Petroleum Exporting Countries), the US as well as Russia – collectively accounting for about 53 per cent of the global total – continues to grow and inventories continue to swell, from the OECD (Organisation for Economic Cooperation and Development) countries, to floating storage in Iran and the strategic petroleum reserve in China.

The US Energy Information Administration says the country’s producers are cutting output in response to the recent slump in prices. 

The latest round of bloodletting in the oil markets and fears of prices testing new lows in the coming months has predictably renewed the question of whether Opec might reverse its strategy and cut output, possibly in cooperation with some of the major producers outside the group.

The question is to what extent the removal of even a few hundred thousand barrels from daily supply would prop up oil prices. And more importantly, what impact that price recovery would have on US production.