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Focus on... Oil

Posted by jdavis on December 31, 2015

I last focussed on Oil only in September, here.  However, it is worth an update.

As I see it, there are two reasons why the oil price has collapsed, namely:

  1. The US$ (the currency used to trade oil and most global trade) has soared.
  2. OPEC, the cartel of oil producing countries led by Saudi Arabia, has pumped as much oil almost as they could.  In 2015, particularly, oil supply has been higher than demand.

 

There is a high inverse correlation between the price of oil and the value of the US$.

Over the last 5 years, there has been something of a mirror between the US$ and the price of Crude Oil.

Over the last year and a half, Oil has of course crashed as the US$ has soared.

 

The reason why OPEC has continued pumping is simple market forces.  In recent years, the US has ramped up production and this has created a glut of oil.  So, the Saudis decided to go for market share.  Thus, they have held up production and supply has exceeded demand and prices have tumbled.  Sure enough, US producers are going bust and US production is now falling.  In fact, global estimates suggest 2016 will see demand above supply.

Global Exloration and Production investment is down around $170 billion, or 20%, in 2015.  It is estimated it could fall 20% in 2016. This would be the first time in 30 years that investment has dropped for two consecutive years. 

Thus, supply can be expected to fall considerably.

 

The Oil price, in fact, has fallen some 67%. 

To put into perspective, how does this compare to prior largest crashes?

'08-09:  down 68%
'90-93:  down 65%
'85-86:  down 63%
'96-98:  down 54%
 

So, historically we've already had a huge crash.

Can oil fall much further?   Sure.  Is it likely?  No. 

And the same goes for all the other commodities too, and the stock markets of Emerging Markets - many of whom are oil priducers.

The next chart shows Oil and the biggest oil producer's stock market - Russia.  There is clearly a high correlation between the oil price and Russia's market.

So, oil is not just an asset class of itself.  It also almost directly informs the prices of oil shares and shares in Emerging Markets.  It seems too, the share prices move in advance of the oil price.  If Russia rises, it seems likely Oil will too.

When we consider the oil market we look at the US$, mainly.  Looking again at the chart, it is possible the US$ is peaking here, for now.  If it falls this could put a boost under the oil price, and associated assets.

 

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