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2016-04-19 12:24:06
Goodbye to $40 oil?
Apr 18th 2016
BETS that Brent crude would continue to rally were at their highest level since 2011, according to Deutsche Bank, when news came on April 17th of the collapse of talks in Qatar aimed at freezing output. The can-do prognoses that had preceded the meeting had beguiled speculators, who were caught out when it became clear that Saudi Arabia, Russia and others could not in fact agree on measures to curb supply, prompting the Brent price to slide to below $42 a barrel on April 18th. The scramble to unwind loss-making derivative trades may only exacerbate the fall in the coming days. But a lot has changed since January, when oil prices fell below $30 a barrel. It s unlikely that oil will shed all of its recent gains.
The debacle in Doha highlights the deep splits in OPEC which are nothing new and how much harder it has become to rig markets through output quotas which is. It is testament to the cartel s desperation that it even tried. Weeks ago Saudi Arabia expressed its reservations about freezing output without Iran, its main strategic rival and a fellow member of OPEC, being party to an agreement. That is the main reason the meeting in Doha broke down. But the Saudis may also have had reservations about striking a deal involving Russia, which rivals it as the world s biggest producer, and with which it has been tussling for market share in Europe, India and elsewhere. The fact that both countries have been producing at or near record levels in recent months suggested that neither was prepared to cede ground.
A renewed slide in oil prices will rekindle concerns about the global economy. Budgets in oil-producing countries such as Angola, Brazil, Nigeria and Venezuela are severely strained. Oil and gas firms, with $2.5 trillion of debt, are also fragile. Last week s bankruptcy filing in Houston by Energy XXI, an explorer with $4 billion of debt, added to concerns about the oil exposure of American banks though only 5% of the debts of the world s energy industry sits on the balance-sheet of the three biggest, JPMorgan Chase, Bank of America and Wells Fargo. That probably does not represent a systemic threat.
The consolation is that the greater the financial suffering of commercially run oil firms, the quicker they are likely to cut back production, which will shore up prices in the long run. The Energy Information Administration, an official American body, says that output in America has fallen by 600,000 barrels a day over the past year. Cutbacks are taking place in the North Sea, China and elsewhere. A strike by civil servants in Kuwait has hit its output. These, more than misplaced hopes for a freeze in production, are the best explanation for oil s rally in recent weeks. The market is working, and OPEC should leave it be.