”Sometimes I’ve believed as many as six impossible things before breakfast.”
Oil traders know how the Queen felt in Lewis Carroll’s famous book, Alice Through the Looking-Glass. The list of impossible things that they are being asked to believe grows almost by the day:
Last week, prices jumped 4% on the basis that strong demand meant US inventories had fallen 14.5 mb in a week. But the drop was more likely due to offshore rig shutdowns and oil import delays caused by Hurricane Hermine
They were also asked to believe that Russia and Saudi Arabia would agree a deal to “rebalance oil markets” – even though the deal would not involve any production cuts, and would allow Iran and Nigeria to increase output
Equally impossible was the earlier claim that China’s domestic demand would drive major price rises – when in reality some of this demand was one-off filling of strategic storage, and the rest was to increase diesel and gasoline exports from its teapot refineries into the Asian market, where margins are crashing as a result
Before this was the claim that falling US drilling rig counts would collapse domestic oil production, even though cost-cutting meant industry major Pioneer said its Q2 production costs ranged between $2.25/bbl – $12.25/bbl
Plus there is still a widely held view that Russia will have to cut output due to low prices, when in fact it is producing record volumes due to its production costs being less than $20/bbl
And, of course, “everyone knew” earlier this year that Iran would never be able to boost oil production to its forecast levels after a nuclear deal – yet its current production is already only 200kpd below its year-end target of 4mbd
There are 100 other “stories” that have appeared in recent years to justify the myth that the world is running out of oil, and that prices need to be much higher than their median value for the past 150 years of $23/bbl.
These “stories” have helped fuel a speculative mania, which has proved highly profitable for commodity brokers and trading exchanges. $51bn has so far moved into speculative commodity trading so far this year – the most since 2009. And central banks have been very happy to supply free cash to support the speculation, in the hope this might help to create inflation and so reduce the cost of the debt created by their stimulus policies.
But, of course, those who actually use the oil – individual consumers, chemical companies etc – then have to pay the higher prices created by the mania. So the end result is to reduce demand and weaken the global economy.
This clash between reality and illusion has created the near-record levels of volatility that we are seeing in oil markets so far this year. But as the chart above confirms, each rally has only produced a pattern of “lower highs and lower lows” – each rally has been weaker than the last one, and prices go lower once it fails.
High levels of volatility are normally a sign that a mania is coming to an end. Oil prices will then be left to find their own value, on the basis of real market fundamentals of supply and demand. That, after all, is the key role of any market, to provide “price discovery”.
WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Brent crude oil, down 54%
Naphtha Europe, down 53%. “Prices rise sharply on Brent hike”
Benzene Europe, down 53%. “US production as well as a lack of Asian imports earlier this year have strengthened US benzene prices into September.”
PTA China, down 40%. “High demand seen in July and August would likely not appear again, in the face of upcoming holidays and shrinking seasonal usage.”
HDPE US export, down 27%. “PE exports rose as the domestic market slackened, with production and sales figures for the month down by low single digit percentages, according to industry data.”
S&P 500 stock market index, up 9%
US$ Index, up 17%