Sharp Reversal in the Price of Crude Oil

08:36, 13 November 2018

After rising to a high of $76.35 a barrel on October 3, when analysts were asking if the price of oil could reach $100 by the end of 2018, it took just five weeks for crude to reverse its course violently.

Both WTI and Brent Crude Prices Fell Last Week

U.S. West Texas Intermediate crude dropped around 20% in comparison to the latest high, at the close on Thursday. It continued falling on Friday, losing $0.48, or 0.8%, to settle at $60.19 a barrel, losing 4.7% for the week. Meanwhile, January Brent crude fell $0.88, or 1.3%, to reach $69.78 a barrel, losing 4.1% for the week. Brent oil was down more than 19% from its recent October peak.

Furthermore, the Friday drop in WTI crude was the tenth consecutive losing session for crude. It’s been more than 30 years since crude posted a losing streak that long. A similar stretch took place from July 18th to July 31st, 1984.

How Did the Sharp Reversal in the Price of Crude Occur?

One of the most asked questions is what happened to cause such a sharp reversal in the price of crude, and is the downturn likely to last?

That question overwhelms many investors and Wall Street experts, especially since it has come in tandem with a downturn in stocks, just when investors thought a recovery from the October sell-off was in the cards.

Could the Downturn in the Prices Affect the World Economy?

Oil is often used as a gauge of the overall health of the economy, with oil prices telling how well the global economy is functioning. However, there are few analysts who think that the recent downturn in oil reflects global economic weakness, or a foreshadowing of something as drastic as a recession.

Many believe that this drop has more to do with Iran and the repricing of markets now that the expected 1 million barrel daily drop in production hasn’t happened.

When sanctions were started by the U.S against Iran, it was expected that the country’s crude production would be removed from global supplies. However, the granting of waivers to the eight largest buyers of Iranian oil has made it necessary for traders to readjust to the market events.

A Jump in the Supply Has Caused the Drop

In short, the drop has been caused by a jump in supply that isn’t likely to be matched by a similar jump in demand.

Even more, the falling oil prices and falling equity prices have very little correlation. In the past twenty years the only time when falling crude has coincided with falling equities was during the 2008 financial crisis. And back then there were many forces in play contributing to the decline in stocks, including the collapse of Lehman Brothers.

Some analysts even believe that a drop in crude prices is a good thing because it can help alleviate inflationary pressures. 

Putting all that aside, stocks have prospered both in situations of $100+ crude and during times when crude fell sharply, such as in 2015.

What Could Happen to Crude Prices in the Future?

U.S. supplies have been increasing for the past seven weeks, and the build is gaining momentum, which has some worried that the global glut of oil is returning. That means crude prices could be dropping back below $50 or even $40 a barrel sometime in 2019.  The market has been in contango (prices for future delivery are higher than spot prices) since mid-October. This can encourage market participants to store crude for later sale.

In addition to the pricing situation, both OPEC and Russia were seemingly raising their own production levels ahead of the sanctions against Iran. That’s contributing even more supply to an already over-supplied market.

And U.S. production isn’t helping. Data from the U.S. Energy Information Administration released this past Wednesday has U.S. production at a record high 11.6 million barrels per day as of the week ending November 2. U.S. production could continue rising too, with Baker Hughes reporting active U.S. oil rigs rose by 12 to 886. This was the largest jump in active U.S. oil rigs since May.

Thanks to the build-up in anticipation of Iran sanctions OPEC production is super-sized. U.S. production is also at record levels. But Iranian oil is continuing to flow unabated due to the sanction waivers for the largest buyers of Iranian oil. And U.S. inventory levels have been building for seven consecutive weeks, while futures prices are above spot prices for oil.


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