Brent: Supply or demand, it's all bearish

On Friday, Oct. 24, 2014 December Brent Crude Oil traded below $86 per barrel. September saw the price of Brent Crude slide 8.3% on London’s ICE Futures Europe Exchange representing the biggest loss in one month since May 2012. We are currently seeing Brent futures trading at levels not seen since 2010, leaving traders asking why. Analysts are pointing to a grimmer economic outlook globally speaking, with growth fears surrounding some of the world’s key economies, including the US, China as well as the Eurozone. However, I am looking at the current situation more in terms of excess supply than weakening demand.

Saudi Arabia has been at the heart of the recent headlines on Brent and with good reason. Saudi Arabia is the largest producer of oil in the Organization of Petroleum-Exporting Countries (OPEC) which, in turn, has a market share of about 43% of all oil produced around the world. A report released on Thursday, Oct. 23stated that Saudi Arabia was cutting production to counteract the fall in oil prices. Oil markets seemed to rally on the news, especially since this was contrary to what the Saudis have been saying recently. However, instead lowering production, Saudi Arabian production levels actually increased by 100,000 barrels; it was simply export levels that were lowered. OPEC is set to meet on Nov. 27 for its annual meeting. Countries like Venezuela and Iran are calling for a cut in production to help stabilize prices. Saudi Arabia may, however, have a vested interest in falling prices as the nation looks to protect its own share in the market. If anything, it will be very interesting to watch what OPEC will decide to do.

While the drop in Saudi Arabian exports may sound like demand weakness, it is more of a supply story: buyers of Brent simply bought oil for cheaper elsewhere. The boom in U.S. oil production has left countries who previously sold oil to the States scrambling for substitute buyers. China has found cheap oil 14,000 miles away in the South American country of Colombia where, last month, they paid an average of $94.56 per barrel compared with shipments from Saudi Arabia purchased for some $102.30.

In reaction to ongoing developments, OPEC members Kuwait, Iran, Iraq, and Saudi Arabia all cut their official selling prices this month. Germany’s Commerzbank cut its average Brent price forecast for 2015 to $85 from $105 on indications OPEC will defend its market share. The weekly chart below shows the December 2014 Brent contract breaking through a support level at $88.49, and we have seen a full week of trading below that level. The increasing volume and open interest shown in the chart indicates there is more downside to come.

 

Source: https://www.tradingview.com/e/Wy1C6EHl/ [accessed 10/24/2014]

At present, there is more oil above ground than ever before. The technological advances in drilling have provided producers more efficient ways to pull oil out of the ground. Coupled with slowing global growth should exert significant downward pressure on oil prices. Crude oil prices may continue to fall in light of current production levels and the fact that no one will want to stop drilling until forced by the markets to do so.

 

 

About the Author

Jack Malone is a Futures and Options Advisor at RCM Asset Management with a focus on the metals and energy markets. Jack can be reached at jmalone@rcmam.com