Oil Storm Beckons

Commodity deflation has arrived as evidenced by tumbling energy products and base metals. The tightening global liquidity situation as evidenced by the outflows from emerging markets and below-trend growth for developed economies show that the economic outlook is unlikely to pick up in the near-term. As such, it is apparent that commodity prices will remain lower for longer, much to the dismay of exporting nations struggling to balance budgets. Oil prices in particular are set to remain subdued owing to the persistent oversupply conditions as exporters race to increase production to offset the losses in revenue. However, these very actions to protect market share and revenues have in many ways caused the spiral lower in prices.  Although there has been a near-term rebound after WTI prices hit a multi-year low, the bounce is likely to be short lived due to a number of external factors.

The Fundamental Perspective

Oil prices are sensitive to numerous influences from both the supply and demand side. From the viewpoint of economics, the intersection of supply and demand is known as equilibrium, or the price at which all production supplied is consumed (or demanded). The supply conditions remain one of the major drivers of prices as evidenced by recent rig count data combined with inventory numbers from the United States. From a production standpoint, the United States has seen lower oil prices hardly dent output which remains not far from multi-decade highs. Even though production has fallen to the lowest level in months, the United States remains in the top three spots of major global producers and shows no signs of increased deceleration in output.

Supply from the shale patch has remained high as companies faced with imminent defaults and bankruptcies keep production high to maintain financial lifelines.  However, the longer prices stay lower, the more companies are likely to bow out from the industry, leaving great opportunities for the vulture financial firms waiting for bargain basement prices on productive ground.  With many firms facing similar difficulties, the next few months will prove critical for the resurgence of the American oil industry. Revolving credit lines are likely to expire and not be renewed as banks pull back the reigns on financing.  However, despite the prospective weakness in the pipeline for the American oil industry, it is not the only nation contributing to the persistent oversupply issue.