On Tuesday, oil prices continued dropping as investors and traders weighed oversupply prospects, dollar strengthening, and refining margins. Brent crude traded down to $39.92 a barrel, while West Texas Intermediate (WTI) fell to $37.06 during the trading sessions.
What are the issues?
Earlier this week, Saudi Arabia decided to end additional output cuts this month, which consequently means that in the coming months, an increase in supply in the market would be inevitable. The end of additional output cuts seems to be subscribed by other Gulf producers as they were also keen on ending further cuts.
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If the OPEC+ party was successful, the afterparty was not. The press conference was not bullish, as the outcome of the meeting, the measures to ensure compliance for members cheating on their quotas sounded weak. The impression that suppliers would self-inspect themselves is the monitoring equivalent of students invigilating themselves during examinations, without any external supervision. Given the mechanical strains in shutting off production and revenue targets by member countries, there would surely be some malpractice. However, Iraq has shown signs of ethical conduct by asking Asian refiners to forgo shipments of its Basrah crude.
Also, the market assessed the tone of the Saudi and Russian Ministers when asked about production policies for August, earlier in the week. Novak, the Russian Energy Minister, claimed that it was too early to say what would happen in August, while Saudi’s Energy Minister also said that it was premature to discuss August’s policies. Bear traders considered that and believed there were no assurances for reducing the supply, which would affect the rallying of prices in the short term.
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UBS Commodity analyst, Giovanni Staunovo stated that, “A slightly stronger U.S. dollar is weighed on crude prices with the prospect of higher production from Saudi Arabia, Kuwait, UAE and Oman in July which would not help prices.”
These events colliding with the impending return of Libyan oil and unrestricted oil production from U.S. and Canada raise an oversupply concern.
Historically, there is an inverse relationship between the price of the U.S. dollar and the price of oil. The reason for this is that when the dollar is strong, fewer dollars are available to purchase oil (remember oil is priced in dollars). With this explanation, a comeback for the greenback after weekly declines has resulted to the increase in its purchasing power. However, traders are expecting the dollar to take a hit, with the “potential FED stimulus” approaching.
Two months ago, there were problems with storage capacity in the oil market. Now, another two-word phrase has been injected to give the bears momentum—refining margins. Defined by Mckinsey, ‘It is an industrial measure of the value contribution of the refinery per unit of input.’ This problem formed a part of Goldman Sachs’s outlook for Brent crude in the short term. The investment bank believes that prices would pull back to $35 because of the collapse in refinery margins and the incoming oil production from the U.S. and Libya.
The bank also said, “the collapse in refining margins to unprecedented lows is reflective of both over-valued crude prices as well as a more moderate demand recovery, two pillars of our short-term bearish view.”
Warren Patterson, head of commodities strategy at ING, signalled caution saying, “if we look at the rally we’ve seen in crude oil prices, it’s been amazing, but the big uncertainty is if you look at refinery margins, they are very weak across the board across all regions.”
Could this be a market correction, or is the market taking a breather after strong rallies in the previous weeks, or are oil prices over-valued? The following weeks would be crucial to know the answer to this question.