CRUDE OIL: BLACK GOLD LOSES ITS LUSTRE

The entire commodities pack is losing its shine and crude oil is no exception to it. It has been the second worst performing commodity after silver in the last four months as seen in the graph alongside. Oil prices have trended lower on oversupply and weak demand since mid-June, when Brent hit a nine-month high of USD 115.71/bbl. In case of WTI crude, the prices touched a high of USD 105.25 on July 22 but have traded lower since then and have continued to be in a declining spree for four months in a row. Brent crude (CMP: USD 91.10) and WTI crude (CMP: USD 87.77) are now trading at two-year lows. The spread between the two variants of crude have reached all time lows at USD 3/bbl. Let us assess how the price performance has been in the time frame discussed and how the world economy is faring up in terms of the GDP and industrial activity.

The reason for such a drastic fall in crude oil prices is due to growth concerns in the world economy at large; slow oil demand; ample global oil supplies; and the intrinsic factors of demand and supply with respect to the US and the OPEC nations. Weak underlying fundamentals, intense speculative behaviour, easing of supply concerns and softening demand has been the story of oil markets in recent weeks. An agreement to open some Libyan ports and resume exports of crude made additional barrels available in the global market and applied downward pressure on light sweet crude oil prices. Low refinery runs in Asia and Europe capped the demand for crude oil and expectations for global economic growth by the International Monetary Fund (IMF) were revised lower.

The IMF on Tuesday, October 7 cut its global economic growth forecasts for the third time this year, warning of weaker growth in core Euro zone countries, Japan, and major emerging markets such as Brazil. While richer countries like Britain and the United States are seeing stronger economic expansion, the IMF downgraded its forecasts for the three biggest economies in the Euro zone currency bloc - Germany, France and Italy - and said it was essential that richer countries maintain monetary accommodation and low interest rates.

In the developing and emerging economies, the sluggish pace of growth has continued into the current year. Russia and Brazil are expected to experience only limited growth this year before slightly improving in 2015. The IMF lowered growth projections for Japan and Brazil, among others. It said that potential growth in the emerging markets is now 1.5 percentage points lower than what it foresaw in 2011. Coming from very high growth levels last year, China is forecast to grow by 7.4 per cent in 2014 and 7.2 per cent in 2015 as the economy continues to mature and the country is in the process of managing its economic imbalances.

Except for India, the other major emerging economies are expected to grow at a lower rate in 2014 compared to last year. Recovering from low growth last year, India is expected to grow at 5.5 per cent in 2014 and at 5.8 per cent in 2015. On the contrary, the IMF warned that geopolitical tensions between Russia and Ukraine, and in the Middle East, were increasingly posing risks to the global economy and could shock oil prices and cause wider trade and financial disruptions if conflicts escalate.

Outlook

Given all such factors and the end of an easy monetary policy in the US, rising interest rates is a mixture that can cause additional outflow of money from commodities into other asset classes. The sputtering business environment in the Euro zone calls for additional steps to be taken by the ECB to lift the economy and in turn demand for commodities as a whole, including crude. China’s growth also remains a cause of concern as the country is trying to correct the imbalances created when the economy was growing at a higher pace. This in turn has resulted in low demand for commodities and does not bode well for the energy markets.

Refineries in the US will be offline on account of maintenance that starts in October. Maintenance on the US Gulf Coast will peak next month at some 5,00,000 barrels per day. This will result in low demand for crude as production would be stocked, in turn creating downside pressure on prices. Although, Iran has urged the OPEC members to make coordinated efforts to help stem the decline in oil, there is a split with others in the oil producers’ group such as Saudi Arabia, which is playing down the price drop. Any coordinated action by the OPEC nations to reduce the output will act as a positive factor for the prices.

The geopolitical tensions between Russia and Ukraine, the ISIS in Iraq, and violence in Libya has failed to pose any threat to the already oversupplied crude markets. A note of caution though: as crude markets react instantly if there are any disturbances in any part of the globe. If the situation in any of these countries escalates, crude prices can reverse their course and trade higher. All these factors make crude oil prices vulnerable to further losses in the coming weeks. NYMEX crude oil (CMP: USD 84.70) prices can possibly head lower toward USD 80/bbl while MCX crude prices (CMP: Rs 5,190) can head lower toward Rs 4,900/bbl.