TALK­ING POINT

We look at the likely tra­jec­tory for Brent Crude af­ter the Black Fri­day crash

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Why is the oil price col­laps­ing?

Black Fri­day is a term typ­i­cally as­so­ci­ated with the re­tail sec­tor, but it could have summed up the mood of board­rooms in oil and gas firms across the globe on 23 Novem­ber when oil hit its low­est level in 12 months af­ter a sig­nif­i­cant in­tra­day crash in prices.

Even af­ter crawl­ing back just above $60 per bar­rel at the time of writ­ing, the global Brent Crude in­dex is still down around 30% from the year-to-date highs above $85 seen in early Oc­to­ber.

A month ago all the talk was of the im­pact on global out­put from US sanc­tions on ma­jor pro­ducer Iran. Ev­ery­one is now point­ing to a big sur­plus of sup­ply and US pres­i­dent Don­ald Trump is call­ing for lower prices.

IS THE FALL IN THE OIL PRICE DUE TO A SUP­PLY GLUT?

The per­ceived risk of over­sup­ply in the mar­ket re­flects the fact the US in­cluded more waivers in its sanc­tions than ex­pected. This meant Ira­nian pro­duc­tion and ex­ports re­mained ro­bust at a time when Saudi Ara­bia had been ramp­ing up its own out­put to com­pen­sate for the an­tic­i­pated short­fall.

WHAT IS HAP­PEN­ING IN THE US?

The US yard­stick West Texas In­ter­me­di­ate (WTI) re­mains at a big dis­count to Brent, at barely above $50 per bar­rel, re­flect­ing the strong do­mes­tic oil pro­duc­tion in the US, although the spread be­tween the two has come down a lit­tle amid the re­cent volatil­ity.

The key in­fras­truc­ture hub in Cush­ing, Ok­la­homa saw stocks fall by 116,000 bar­rels in the week to 21 Novem­ber, the first de­cline in nine weeks.

WHAT ELSE IS CON­TRIBUT­ING TO THE FALL?

Oil, like other com­modi­ties, is driven by sup­ply and de­mand fac­tors, yet fi­nan­cial spec­u­la­tion also plays a role.

AJ Bell in­vest­ment di­rec­tor Russ Mould com­ments: ‘Fun­da­men­tals such as sup­ply and de­mand will ul­ti­mately pre­vail – and the OPEC car­tel clearly has an in­flu­ence on sup­ply since it pro­duces around a third of the globe’s daily oil re­quire­ments – but they can be drowned out in the short term by spec­u­la­tion, as traders (us­ing lever­age, or bor­rowed cash, to try and max­imise re­turns) move in and out of po­si­tions via the fu­tures mar­kets.’

Mould notes that since the num­ber of short or ‘sell’ po­si­tions fell to a record low this sum­mer, they have since started to tick up, while at the same time buy­ers of oil (those with long po­si­tions) have started to lock in profit. This ex­ac­er­bated the weak­ness in the oil price.

Traders were likely re­act­ing to the wider mar­ket sell-off of so-called ‘risk’ as­sets, of which oil is one, and the per­ceived risk to de­mand from global ten­sions over trade.

IS THIS IS A RE­PEAT OF THE 2014 CRASH?

The oil an­a­lyst team at Cana­dian bank BMO don’t think so. They com­ment: ‘The col­lapse in crude oil prices over the 2014-2016 and 1998-1999 pe­ri­ods were driven largely by ex­cess sup­ply as OPEC mis­judged mar­ket con­di­tions. This trans­lated to a sig­nif­i­cant build in global crude oil and prod­uct in­ven­to­ries that weighed on crude oil and pe­tro­leum prod­uct prices.

‘We do not see a re­play of this (sit­u­a­tion) in 2019 as­sum­ing OPEC re­duces pro­duc­tion lev­els in recog­ni­tion of higher pro­duc­tion from Iran. Global in­ven­tory lev­els are in line with his­tor­i­cal av­er­ages and should not prove prob­lem­atic given our de­mand as­sump­tions,’ adds BMO.

CAN THE IM­MI­NENT OPEC MEET­ING MAKE ANY DIF­FER­ENCE?

Pro­duc­ers’ car­tel OPEC is widely ex­pected to take some ac­tion to curb out­put at its meet­ing on 6 De­cem­ber. In the cur­rent cli­mate this is likely to do lit­tle more than sta­bilise oil prices. If OPEC fails to act, then an­other big fall can­not be ruled out.

HOW WILL THIS IM­PACT THE OIL AND GAS IN­DUS­TRY?

Oil ma­jors like BP (BP.) and Royal Dutch Shell (RDSB) re­sponded in the wake of the 2014 oil price crash by stream­lin­ing their op­er­a­tions. This should al­le­vi­ate con­cerns over their ca­pac­ity to main­tain gen­er­ous div­i­dends, a key sell­ing point of their shares.

Fourth quar­ter per­for­mance may re­flect the weak­en­ing oil price and could lead to wider scru­tiny over in­dus­try spend­ing plans for 2019. It could there­fore be bad news for the oil ser­vices space, which had just started to reap the ben­e­fits of oil’s re­cov­ery.

BMO be­lieves any re­duc­tion in spend may have longer-term pos­i­tive im­pli­ca­tions for the oil price with al­ready too few projects sanc­tioned to de­liver the re­quired growth in sup­ply be­tween 2020 and 2025. By Tom Sieber Deputy Ed­i­tor

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