Oil and the state of global mar­kets head­ing into April

Financial Mirror (Cyprus) - - FRONT PAGE -

Good Fri­day and Easter Mon­day put the brakes on global trade in eq­ui­ties, cur­ren­cies, com­modi­ties and in­dices. Trad­ing ac­tiv­ity on Wall Street ended early on Thurs­day af­ter­noon with the Dow Jones In­dus­trial Av­er­age clos­ing at 17,515.73 (+13.14) for a gain of 0.08%. For the past year, the Dow Jones is down 1.14%. The S&P 500 index closed at 2,035.94 (-0.77) for a loss of 0.04%. The NAS­DAQ Com­pos­ite Index closed on Thurs­day, March 24, at 4,773.51 (+4.64) for a gain of 0.10%.

How­ever, ma­jor av­er­ages across Europe were largely neg­a­tive, with the Euro Stoxx 50 clos­ing 1.83% lower at 2,986.73, the FTSE 100 clos­ing 1.49% lower at 6,106.48, the DAX 1.71% lower at 9,851.35 and the CAC 40 clos­ing 2.13% lower at 4,329.68. While Euro­pean mar­kets were lan­guish­ing with poor per­for­mance (Brexit con­cerns and the twin ter­ror at­tacks in Brus­sels), ma­jor av­er­ages across the Pa­cific were do­ing quite well. The Nikkei 225 gained 0.65% to add 110.42 points on the day to close at 17,002.75. Like­wise, the CSI 300 gained 0.50%, up 15.97 points to close at 3,197.82. And lastly the MSCI AC Asia-Pa­cific index gained 0.36% to close at 127.88 for a gain of 0.46 points.

Crude oil re­mains front and cen­tre. Over Easter week­end, US mo­torists were given an­other rea­son to cel­e­brate with the lowest fuel costs in 12 years at the pump. Gaso­line prices av­er­aged $2 a gal­lon across the na­tion and this trans­lated into sav­ings of $9 bln for US mo­torists since Jan­uary 1, 2016 (year on year). This trans­lates into $45 per driver in sav­ings, de­spite in­creased gaso­line con­sump­tion in the first quar­ter of 2016. Year on year, the cost per gal­lon was vastly dif­fer­ent: prices be­tween Jan­uary and March 2015 av­er­aged $2.42/gal­lon, and when we ex­trap­o­late two years back, the price was ap­prox­i­mately $4/gal­lon.

Re­mem­ber that crude oil was priced at $105 a bar­rel back in June 2014 and it de­clined to as low as $27 a bar­rel in Jan­uary 2016. The dra­matic drop in the fuel price has been spurred by shale oil pro­duc­tion in the US. This has re­sulted in a mas­sive spike in global pro­duc­tion as OPEC and nonOPEC coun­tries com­pete with one an­other for mar­ket share. The vir­tual col­lapse in the price of crude has brought about wide­spread de­fla­tion­ary fears in the econ­omy, and weak­ness in the price of oil is only now start­ing to turn the cor­ner. From its Jan­uary lows, crude oil is now hov­er­ing around $40 per bar­rel, lead­ing the mini-resur­gence for the global econ­omy.

The Saudi Ara­bi­ans have now adopted an up­per and lower price range for the price of Brent: $20 on the low end and $40 on the high end. In Jan­uary 2016, the Saudi Ara­bi­ans were ac­tively cam­paign­ing for a freeze on oil pro­duc­tion in or­der to sta­bilise prices. Back then, oil was priced dan­ger­ously low and was head­ing to­wards $20/bar­rel, per­haps less. With over­sup­ply dog­ging the mar­kets, the only pos­si­ble way to raise crude oil prices is to limit sup­ply. The Saudis and the Rus­sians got to­gether with other oil pro­duc­ing coun­tries from OPEC to dis­cuss a pro­duc­tion freeze when they met in Doha. Those plans were sub­se­quently scut­tled as Iran – a ma­jor oil pro­duc­ing na­tion – vowed to do no such thing. The Saudis fol­lowed suit and do not wish to sac­ri­fice mar­ket share at the ex­pense of a po­ten­tial price rise in oil.

For now, Saudi Ara­bia will do ev­ery­thing in its power to pre­vent the price of crude oil from ris­ing too much above $40/bar­rel be­cause that level makes it lu­cra­tive for Amer­i­can oil pro­duc­ers – shale oil pro­duc­ers – to re-en­ter the trad­ing arena. The long-term ef­fects of in­creased par­tic­i­pa­tion of Amer­i­can oil com­pa­nies is the degra­da­tion of OPEC and oil prices. How­ever, there is an al­ter­na­tive school of thought that states the Saudis are quite happy to keep oil prices de­pressed be­cause the Rus­sians and the Ira­ni­ans are us­ing pro­ceeds from oil to fund ex­trem­ist groups that are in­tent on desta­bil­is­ing or over­throw­ing the Saudi Ara­bian regime. But the fact of the mat­ter is that a price freeze among four ma­jor oil-pro­duc­ing coun­tries, in­clud­ing the Rus­sians and the Saudis, is in­suf­fi­cient to make a dent in the global sup­ply/de­mand co­nun­drum.

Saudi Ara­bi­ans is fac­ing a damned if you do, damned if you don’t sce­nario. If the price of oil rises too high, it en­tices shale oil pro­duc­ers to in­crease their pro­duc­tive ca­pac­ity, and it also pro­vides boosted rev­enues to Saudi Ara­bia’s neme­sis – Iran, a clearly an un­ten­able situation. The flip­side is equally wor­ri­some for the Saudis; low oil prices mean that it is burn­ing through its vast forex re­serves and de­plet­ing what was once a healthy sur­plus. The pre­pon­der­ance of low oil prices means that the king­dom will be un­able to make good on its so­cial wel­fare com­mit­ments which are al­ready tak­ing se­vere strain.

The fis­cal and so­cial bud­gets of Saudi Ara­bia re­quire an oil price of $80 or more per bar­rel in or­der to be bal­anced. In 2015, the Saudi bud­get deficit spiked as much as $90 bln. Since 2000, the costs of the so­cial pro­grammes in Saudi Ara­bia have risen dra­mat­i­cally, and this is a source of con­cern for the king­dom which re­lies on high oil prices to main­tain a bal­ance. At the present time, it is not en­tirely clear what would be most ben­e­fi­cial to Saudi Ara­bia, per­haps a price that pre­vents the enemies of the king­dom from fund­ing ex­trem­ist and di­vi­sive el­e­ments in­tent on up­root­ing the po­lit­i­cal or­der, and the main­te­nance of so­cial pro­grammes which have now be­come piv­otal to the sur­vival of the po­lit­i­cal hi­er­ar­chy.

The price of WTI crude oil spiked in June 2008 to $138.91 a bar­rel, but quickly plunged to as low as $33.17 a bar­rel by De­cem­ber 19, 2008. The up­ward climb then kicked into high gear as the price of WTI crude in­creased to $109.62 on Septem­ber 9, 2013, and sta­bilised, drop­ping slightly to $107.49 on June 13, 2014 be­fore plung­ing to $29.71 on Fe­bru­ary 8, 2016. If we ex­trap­o­late back to Jan­uary 2, 1986, the price of crude oil per bar­rel was $25.56, and today’s price of $39.46 is just 33% higher than the price 30 years ago.

Of course, the price of crude is in­flu­enced by fac­tors such as de­mand and sup­ply, as well as the strength of the USD. The weaker the dol­lar, the greater the de­mand for crude oil since it is a dol­lar-de­nom­i­nated com­mod­ity. We have seen sev­eral in­ter­est­ing de­vel­op­ments tak­ing place with the USD of late. For starters, the Fed made an an­nounce­ment on March 16 that it would likely only is­sue two in­ter­est rate hikes for the year. This sup­pressed the dol­lar rally and al­lowed for emerg­ing mar­ket cur­ren­cies to soar. This is also good news for the price of crude and for in­fla­tion targets to be met in the US and world­wide.

The re­cent ter­ror at­tacks in Bel­gium sapped con­fi­dence out of the cur­rency mar­ket, which is al­ready lan­guish­ing un­der poor liq­uid­ity. The safe money ex­ited Europe and found refuge with the USD, giv­ing rise to a strength­en­ing US dol­lar, as ev­i­denced by the resur­gent US dol­lar index. How­ever, this does not bode well for the price of crude and other dol­lar-de­nom­i­nated com­modi­ties. Since for­eign coun­tries find it more dif­fi­cult to pur­chase crude oil in USD when their cur­ren­cies are rel­a­tively weaker, de­mand de­creases. We have seen a dra­matic weak­en­ing in the price of crude oil for the days lead­ing into the Easter week­end. Dol­lar weak­ness will be bol­stered by a Fed­eral Re­serve Bank in­ter­est rate hike in April, if it comes to pass and this will keep oil prices de­pressed for quite some time.

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