The Slowdown in Oil Markets

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  • Worries everywhere…
  • Two revealing earnings reports
  • Plus, the deadline in place for a potential bull run

US stocks shed nearly 1.5% in the last session.

Mr Market is grumpy.

What ails the old goat? He doesn’t like the look of China. It’s too saturated in debt and the Yankees aren’t helping.

Europe is a tired old mess. If it isn’t the Italians trying to prop up their banks, it’s the French rioting.

Even the Brits can’t run a tight ship. They can’t work out what to do after getting what they voted for. Divorces are always messy.

Oh dear. Perhaps tomorrow will be brighter. We know Mr Market is manic depressive.

One minute, he can’t see anything good in the world. The next, he’s as giddy as a love-struck schoolgirl.

We’ll go mad if we respond to his moods every day. The way to avoid that is to focus on the longer term.

And that puts one commodity in the spotlight, thanks to a recent investor update…

It came from Schlumberger, which provides services to the global oil industry.

This company has two fingers on the energy market pulse, at all times. Last week, it released its fourth quarter results.

The financial numbers aren’t of much interest to us. But the commentary of the CEO Paal Kibsgaard certainly is.

He pinned the big drop in oil late last year primarily on surging US shale output.

Here’s where things get interesting…

Kibsgaard also thinks US shale oil is unlikely to keep churning out at the same prodigious rate.

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That implies a recovery in oil this year.

The benchmark US crude price is around US$50. That’s low enough for the shale drillers to reign in some of their capital spending.

They’re also under pressure to show a return to their investors.

Kibsgaard argues the shale drillers will seek to align their capital spending to their cash flow. That puts a limit on how many new wells they can drill.

This would be a significant shift. The US shale boom has been generated almost entirely with borrowed money.

Halliburton, another US oil services company, also forecast lower spending in its earnings announcement.

This slowdown is already happening…

Cracks and pressures forming in oil

Oil collapsed in October last year.

John Kemp at Reuters suggests oil price signals have a lagged effect on production. He puts the overall delay at nine to 12 months.

The rapid output of shale in 2018 was on the back of stronger prices in 2017.

That puts the second half of 2019 in the crosshairs for a slowdown in US production.

That will be an inauspicious time for this to happen. Global shipping rules requiring clean-burning diesel are due to come into effect in January 2020.

Already this is a bit of a problem. Argus Media reports that the US refining industry is pressing the White House to not impose sanctions on Venezuela.  

That’s because it needs to maintain access to the ‘heavy’ crude that Venezuela produces. US shale is much ‘lighter’ and therefore can’t easily replace this type of oil.

This is a tricky balance for the American government. It does not view the recent ‘election’ of President Maduro as legitimate.

The US is also under pressure to help resolve the humanitarian crisis in Venezuela.

That’s not all…

Catalysts for major price swings coming up

Another component to the oil price collapse last year was Iranian sanctions.

The market began to price this in…only to see the Trump administration authorise several waivers for countries like South Korea and China.

More Iranian oil on the market meant more supply, just as US oil output was surging as well.

Those waivers are up for renewal this year…and are unlikely to be renewed.

This could put pressure on the price of oil again.

Now, a bullish narrative around oil could come as a surprise. After all, China is clearly weakening and it’s the biggest oil importer in the world.

However, the link between economic growth and commodity prices isn’t always clear cut.

Oil had a barnstorming decade in the 1970s, even though those 10 years were marred with general economic malaise. 

It’s also possible that the physical movement of oil — in the short term at least — is becoming subordinated to positioning in the American futures markets.

This is a recipe for wild swings and many conflicting signals.

For example, it would have been easy to view the collapse in oil last year as a signal of weak demand and the threat of recession.

In October last year, the US Energy Information Administration (EIA) forecast WTI oil to average US$72 a barrel in December 2018.

It got the production and consumption numbers right, but the price wrong. It averaged around US$50.

Energy economist Philip Verleger suggests this new dynamic stems from Wall Street investment banks protecting themselves from the hedges they’ve sold to American oil firms.

Suffice to say, there could be a lot of opportunity to make money in oil this year, but prepare to strap yourself in for a wild ride.

All the best,

Callum Newman Signature

Callum Newman,
Editor, Profit Watch

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