How is the threat of conflagration affecting the price of Oil ? As it happens, not that much ......

Tuesday 5th January 2016

How is the threat of conflagration affecting the price of Oil ? As it happens, not that much ......

ref :- "Crude swings violently on Mideast tensions" , the Financial Times, Markets and Investing p.30

Well, if the first trading day of 2016 is anything to go by we're in for a difficult year ..... poor manufacturing data in China prompted a 7% sell-off on the Shanghai Composite which duly spilled over to global equity markets. Just to make matters worse, the US put out some weak manufacturing data of their own (as did the UK, incidentally). The Chinese numbers and their bearish implications for the economy weighed once more on industrial commodities, and the dramatic escalation of antagonism between Saudi Arabia and Iran cast a gloomy shadow over all markets. Interestingly, for the first time in quite a while Gold benefitted from safe-haven buying  --  in recent times it has seemed that the yellow metal had lost its attraction on that front. And what about Oil, always at the heart of things when events turn nasty in that region ? Just a bit higher at the finish (and a bit lower today as we write) , and certainly no evidence of any panic buying.

The knee-jerk reaction to the news that the two big powers of the region had withdrawn diplomatic relations and were squaring up to each other (thankfully only rhetorically so far) was of course to buy the market. This is hardly surprising when you consider what might happen if you were to take the most pessimistic view for future developments. Plainly the market didn't subscribe to that view and seems a little undecided as to what it might all mean for the oil price. We've been here before with Saudi Arabia and Iran, and by common consent they are already fighting proxy wars in Yemen and Syria. In these circumstances traders could probably take a bit more bellicose rhetoric in their stride. Any sign that the two might come into direct military contact would of course be an entirely different matter, and a catastrophic one at that. Let's hope we don't get to find out just what kind of effects such a scenario would have.

Actually, counter-intuitive though it sounds, one could make an argument that these developments might be bearish for oil. Perhaps prompted more by hope than expectation, there has been the odd whisper that sometime over the next few months OPEC might call an unscheduled meeting to cobble together an agreement to support prices once Saudi's aim has been achieved. Right now, it's hard to imagine the two biggest players being in the same room together never mind being able to act in partnership. And if you assume that Iran will not jeopardise the lifting of sanctions by contemplating military action, we're back to the situation where the fundamentals seem unremittingly bearish for oil prices right now.

In their New Year forecasts, most commentators expect oil to be higher than current levels in a year's time. The logic behind the thinking is that low prices have caused the cancellation of hundreds of billions of dollars of investment in the industry, and sooner or later this will feed through to supply. Fair enough, but that's not likely to be a factor until much later in the year. For the immediate future, there is only likely to be over-supply. Assuming events don't interfere with the lifting of sanctions, Iran is about to pump an extra 500,000 bpd onto a market already facing a glut, and that figure will soon rise to 1m bpd, so they tell us. As for the Saudis, if anyone was in any doubt about their determination to see out their plan to win back market-share by continuing to pump cheap oil then they should be convinced by Saudi's recent imposition of an "austerity" package whilst prices remain so low. (This may not be an austerity package that a Greek might recognize say, but for a state with a history of subsidising its citizens so hugely it's a radical and slightly risky step).

Inventories remain so high that finding the capacity to store oil stocks is a genuine concern, and as for demand ..... it remains vulnerable to any slowdown in global growth projections, and the most recent manufacturing data won't help. So, for the time being at least, it's all bearish again. Well yes, .....

BUT......

Though it is almost impossible to find anything fundamentally bullish about this market (assuming the Saudi / Iran situation doesn't get completely out of hand), it's looking like a good deal of caution would be advisable. That's always the case when so much of the speculator interest is positioned in one direction (i.e. in this instance, short). Such markets are vulnerable to sharp reversals, as price movements caused by traders squaring positions cause others to rush to do the same. Often there is little or no fundamental reason for such moves  ---  remember in late August, seemingly on the back of some fairly unimportant inventory numbers, crude prices spiked over 20% in a week before resuming the downtrend. It would only be sensible to assume that such spikes could happen again.