Crude oil has officially entered into a bear market, with West Texas Intermediate (WTI) crude prices down over 20% from their highs in early October. The selloff in oil was as drastic as it was sudden. Prices have approached $50 per barrel of WTI, the lowest price since November of 2017. What happened to oil and why did the move occur so suddenly?
Source: Nasdaq 11/2018.
Several key factors contributed to the oil rout of the past several weeks. There are three factors that come into play here: geopolitics, oil supply and technical momentum. Let’s address each item separately.
Oil is a commodity that will always be influenced by geopolitics. With a good portion of the world’s energy reserves based in the Middle East, it seems that oil prices are consistently influenced by diplomacy. And this would be the case in the last few weeks as well, related directly to the Trump Administration’s renewed sanctions on Iran. President Trump announced renewed sanctions on Iran with respect to the nuclear deal several months ago. The sanctions would have the effect of preventing Iranian crude oil from being accepted by many international trading partners, like India, Japan and China. Initially, oil prices spiked in anticipation of new sanctions. But just before being enacted, the U.S. government in recent weeks has provided waivers to many of Iran’s biggest oil importers. The effect was to shock oil markets to the downside, as the Iranian sanctions were initially believed to have taken off approximately 1 million barrels of crude oil per day from the global marketplace. With this oil now going to its trading partners around the world, Iran is supplying far more oil than was expected. Source: The Wall Street Journal. https://www.wsj.com/articles/how-iran-sanctions-wrongfooted-oil-bulls-1541527315
Supply and demand play a critical role in the price of crude oil. In anticipation of Iranian sanctions, Saudi Arabia has turned on the tap, exporting oil to the world at record levels in recent months. U.S. crude oil supplies have grown in recent weeks as a result of increased exports from Saudi Arabia, along with increased domestic production. When supplies of crude oil grow, typically prices fall. The opposite is also true, as oil prices tend to rise when supplies fall.
Commodities also tend to have technical price movements based upon trading. Due to the sudden downdraft in oil prices, investors and speculators that were net long began selling oil to hedge their portfolios. Market makers like big Wall Street firms were also forced to sell oil as a form of hedging their own books. The result was to exacerbate the already large losses in the crude oil market.
Is there a silver lining to the fall in oil prices? The answer is yes. Every price cut in oil directly impacts the price of gasoline for U.S. consumers. A large price cut for gas is effectively a tax cut for U.S. consumers, allowing them to spend additional dollars elsewhere. Moreover, headline inflation is largely kept in check when energy prices fall.
We continue to monitor the latest developments in the energy world. So far, their impact has been muted with respect to the U.S. financial markets. We expect to see a return to greater price stability in the coming weeks.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful. The fast price swings in commodities and currencies will result in significant volatility in an investor’s holdings.