I’m a believer

Published at 12:43 12 Feb 2018 by . Last edited 15:12 5 Nov 2018.

Crude markets have been dragged down by the general repricing in markets given rising interest rates and volatility. Counterintuitive as it may be, the reason that the market got spooked and built in prospects of more Fed hikes was positive economic data—US wage growth accelerated, PMIs in Europe surged, and emerging market data was robust. There is such a thing as too bullish.

There was also an oil-specific factor that shook the bulls’ confidence—the EIA’s weekly US production estimate, which showed a 0.33 mb/d w/w rise in output. This figure is an estimate based on the agency’s Short-Term Energy Outlook (which raised 2018 US output estimates by 0.33 mb/d) rather than an actual reading. US crude production will rise strongly this year—by around 1 mb/d—but the EIA’s figures are subject to revision and should not be taken at face value. Therefore, there is also no risk that Saudi Arabia will abandon the OPEC deal in June.

The US data and the macro correction come at a time when the physical fundamentals for oil are seasonally at their weakest—while Brent spreads have held remarkably well, crude differentials in the Med and Asia have fallen further. Products markets are also weak amid record refinery runs and the weather has not been particularly supportive for diesel in West of Suez markets. 

The pace of the sell-off has been impressive, but those who have swung to seeing all news as bearish are getting ahead of themselves. Real economy indicators like petchem prices (rather than feedstock prices) are proving resilient—indeed, they are rising even as oil tumbles. To call a bottom would be foolish but given fundamentals have not changed, the likely return of Chinese buying in early March and the expiry of the April Brent contract may be the catalysts for a change.

US risk asset performance, indexed=1 Jan Ethylene vs Brent crude, $ per tonne
Risk asset performance Ethylene vs Brent
Source: Bloomberg, Energy Aspects Source: Reuters, Energy Aspects

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