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Market watch
Why OPEC cuts failed to rally the market? Some inconvenient truths of oil market 'fundamentals' by Matthew Hulbert and Tariq Akbar of Datamonitor.
Strange things have been happening in oil markets of late.
Classic price signals such as falling oil reserves, economic quagmire in the Organisation of Economic Cooperation and Development (OECD) countries and slackened growth in emerging markets all failed to quell the market on the way up to July, while geopolitical flashpoints, storms looming over the Gulf of Mexico and even production cuts by OPEC memeber states are now failing to stop its decline.
This raises a number of ‘inconvenient' truths as to the self selecting nature of ‘fundamentals' in play at any given time in oil markets.
Red rag to a bull, or is that bear?
During a stampeding bull market up to July 2008, traders failed to let news of sharp falls in US employment figures or weakened growth in Asia cool the market, as speculators piled into oil as a hedge against the weak dollar amid rising inflationary pressures.
The longer term cause of this upward run was the fact that financial investors were convinced that tight supply-demand fundamentals could be exploited as they built up a large net long position in crude oil futures from 2004 onwards.
Every scrap of geopolitical friction was seized upon to push prices up; the hijacking of a small Japanese oil ship passing through the Gulf of Aden prompted the market to hit $117/b while intractable conflicts in Iraq and Nigeria alongside fears of production cuts in Libya, all supposedly served to bring supply-demand fundamentals closer together.
Rumblings in Latin America were billed as a potential ‘Andean cataclysm' rather than a largely predictable and well rehearsed contratante between Venezuela and Colombia.
Even failed Presidential candidate, Hilary Clinton, managed to move the market by firing a ‘virtual warning shot' across Iranian bows.
Contractual instability for International Oil Companies (IOCs) operating in Russia and Central Asia also came as a supposed ‘surprise' to the market in restricting Non-OPEC supply, which admittedly, still has more mileage than the death of Benazir Bhutto drawing supply-demand fundamentals closer together when pushing the markets to brink of $100/b in the closing hours of 2007.
Little wonder then, that despite a lack of any major change in market fundamentals (beyond Saudi Arabia working towards a record 12.5mb/d output by 2009) investment banks started to hint towards forecasts of $200/b.
Not to be ‘outdone', Gazprom nudged estimates a little higher hitting $250/b, a figure that many analysts started to present as a self fulfilling prophecy as the markets approached the $150 mark in July 2008.
But just as the rising market wouldn't let weak employment figures or dampened growth forecasts stop the oil markets meteoric rise, it is now highly unlikely that a declining market will let 'minor' inconveniences such as heightened contractual instability in oil producing states or major geopolitical flashpoints stem its decline.
Long standing OPEC stubbornness to increase output no longer appears to be a major problem, nor does entrenched difficulties in the Niger Delta.
The fact that Evo Morales has been fighting for his political life in Bolivia as Pervez Musharraf desperately clung onto his last vestiges of power in Pakistan has barely touched the sides as the oil price slipped to $112/b.
Iran's threat in early August to block the Strait of Hormuz should Tehran be attacked, also failed to register, (a point which stands in stark contrast to the $6 spike following Iranian missile tests merely a month earlier).
Wall Street runs its course
This all points us towards our first inconvenient truth; namely, that speculation has added a sizeable chunk on the oil price in capitalising on tight market fundamentals.
Given that the latest 'price signals' in the Caucuses over the fraught existence of the BTC pipeline and broader access to Central Asian oil reserves that feed it, or storms in the Gulf of Mexico, have actually prompted the oil market to drop even further (hitting $106/b), provides unequivocal evidence that the market is currently being dictated by financial investors unwinding their net long positions to realise capital gains and release liquidity, rather than any shorter term price signals in play.
Such events, merely two months ago, would have made prices above $170/b entirely conceivable.
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