Here’s Why Oil Markets Are Crashing This Week

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May 5, 2017 6:52am NYSE:UCO

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From Nick Cunningham: WTI and Brent continued to tumble on Thursday, dropping to their lowest levels since the announcement of the OPEC deal back in November. Brent actually dipped below $49 per barrel, raising fears of another downturn. Both WTI and Brent were off by nearly 4 percent during midday trading on Thursday.


Oil traders have been patient, hoping that despite the rapid rebound in U.S. shale production, the OPEC cuts would take a substantial volume of oil off the market and correct the supply/demand imbalance. But it has been a painful and protracted process.

U.S. crude oil inventories hit a record high of 535 million barrels as recently as the end of March. Several consecutive weeks of drawdowns in April again raised hopes that the market is heading towards balance, but the most recent data release from the EIA on May 3 disappointed yet again, and it was apparently the last straw for some. Market analysts predicted a drop in oil inventories by about 2.3 million barrels, but the EIA said stocks only fell by 930,000 barrels. WTI sank to $46 per barrel and Brent fell into the $40s for the first time in 2017.

Worse, gasoline stocks increased slightly, offering more evidence that motorists are not willing to burn through all the refined products that the downstream sector is producing. Even if refiners suck more crude out of storage, consumers won’t sufficiently burn through all of the additional refined product.

But the most bearish part of the report came from the upstream figures, which once again showed dramatic growth in U.S. oil production. In the last week in April, the industry added another 28,000 bpd, taking U.S. output up to 9.293 million barrels per day (mb/d), up more than 200,000 bpd since the beginning of March, and up more than 450,000 bpd since the start of the year. Output is now the highest since the summer of 2015, and if current trends continue, the industry could break all-time production records before we know it.

U.S. oil production “continues to grow hand over fist, and the market will remain well oversupplied given the lack of” demand for gasoline and diesel, Roberto Friedlander, head of energy trading at Seaport Global Securities, told CNBC.

It is growing more difficult by the day to make the case that oil prices will post strong gains this year. A WSJ survey of 14 investment banks finds an average projected Brent oil prices for this year at $57 per barrel, an estimate that is starting to look a bit overly optimistic.

“Crude inventories fell, because they always do at this time of year,” Stephen Schork, president of Schork Group Inc., told Bloomberg. “This is the 11th straight-weekly gain in production and heading for a modern-day record by the end of the year. I don’t see any way you can spin this as bullish.”

Adding to the supply glut is the fact that Libya has restored large chunks of its production, taking output back above 700,000 bpd. Libya’s National Oil Company is also targeting another 500,000 bpd of gains this year, although that will be easier said than done.

Things are not all bad. On the plus side, hedge funds and other money managers have reduced their bullish bets on crude oil, which is to say, they are not overextended on the upside in the way that they were the last time oil prices fell. That means there is less pent up pressure that could suddenly force prices down further. “We’ve had some pretty sharp price corrections already so it does reduce the risk of length liquidation. I do think as long as OPEC maintains the cuts, the price will get some stability,” Petromatrix analyst Olivier Jakob said to CNBC.

And although it gets lost in the mix, especially when prices start getting volatile, the market is still marching slowly in the right direction. Inventories are declining globally, and many analysts still see more balance later this year.

Moreover, the markets tend to put too much emphasis on one indicator over another. OPEC was given enormous credit in the initial rally up to $50 last November, but some argue that the large OPEC cuts, which are likely to be extended through the end of the year, are now being discounted as everyone shifts their focus to the shale comeback. “U.S. production continues to rise largely in response to supply discipline being shown by OPEC and Russia,” Tim Evans, an energy analyst at Citi Futures Perspective, said in a Bloomberg interview. “It was a mistake during the first part of the year to ignore rising U.S. production and focus exclusively on the OPEC cuts. It’s a mistake now to just focus on U.S. production and assume that guarantees we’ll have an ongoing abundance of supply.”

But the problem with that argument is that to a large degree the OPEC extension has already been priced into the markets. That leaves little upside to an extension but a massive risk to the downside if OPEC fails to extend.

The ProShares Ultra Bloomberg Crude Oil ETF (NYSE:UCO) rose $0.01 (+0.07%) in premarket trading Friday. Year-to-date, UCO has declined -35.74%, versus a 6.81% rise in the benchmark S&P 500 index during the same period.

UCO currently has an ETF Daily News SMART Grade of D (Sell), and is ranked #82 of 127 ETFs in the Commodity ETFs category.


This article is brought to you courtesy of OilPrice.com.


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