Why so down, Oil?

You’ve seen the charts on oil, and they are grim. Oil fell over 10% after OPEC announced they were not cutting production, and this is after an already dramatic drop since July.

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Some people are saying it’s all supply related – that we have a glut of oil now (or maybe a glut of high priced oil). Others insist its all demand reltated – that the recession in Europe coupled with “only” 7% growth in China is enough to push oil lower.

But there has to be some speculative unwind here. The fall is too large, too fast. There is no new information in the market we didn’t have last year about supply – it’s been long known the world was able to supply a large amount of oil at $100/barrel. And while demand is slowing, should this result in a 30-40% price drop?

I suspect over the next year we are going to see a new price equilibrium of $60-70/barrel oil, even after China and emerging markets pull out of their moderate slump. And we’re going to have to deal with the odd fact of lower oil prices.

One of the answers to this is there has been a large speculative bid in oil predicated on higher inflation which has never materialized, a bid which cannot stand a few months of lower oil prices. As this unwinds, we could see some very low prints in oil, and the new price regime could be quite low.




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2 years 6 months ago

There was an FT article that the removal of banks as holders of oil liquidity may have played a part. The article said something about the liquidity premium moving from banking to producers and kicking out speculators in the process (I probably got that wrong; I didn’t understand it really). But it would be an explanation for large holders of oil to quickly cease adding demand.

Another explanation I saw was a move from contango to backwardation. If speculators were expecting profit from rising oil prices, a sustained realisation that oil prices went into backwardation could lead to a rapid unwinding of long positions. That would trigger more capitulation and further falls – classic crash behaviour.