Why Oil is a worry

Oil prices have been crashing; and it could get worse…

A few days ago, the Norwegian government quietly acknowledged that they may have to start drawing down from their Sovereign Fund if oil prices fall further. This is significant! The Norwegian Sovereign Fund manages close to $1 trillion and is the largest sovereign fund in the world. This fund was created with the power of Norwegian oil at the peak of the oil price boom. With oil below $50 / barrel, things could get a lot worse!

Wither summer demand?

Year 2015 was negative for crude oil in more ways than one. For the first time in history, oil prices fell by 30% during the summer season. Now for some background! Summer season is considered peak season for oil demand. Most refineries across the US and Europe work at full capacity during summer and therefore demand for crude is at its peak. Also nations like the Middle East and the rest of Asia consumes tons of oil to fire up their air-conditioners. Finally, this is holiday season across the developed world and gasoline demand is at its peak. Despite all these factors, oil has crashed 30% this summer. This is worse than the previous crises of 1986 and 2008.

OPEC no longer in control…

It is now clear that the OPEC is no longer in control of crude oil prices. Oil production in the US and Russia have almost been equal to the barrels churned out by Saudi Arabia. Obviously, Saudi Arabia no longer exercises complete hold over crude oil prices. Secondly, with African nations like Nigeria entering into spot pricing contracts with buyers, Saudi Arabia realizes that maintaining market share is more critical. And if the lifting of sanctions brings Iranian oil into the global market, things could get much worse for crude oil prices.

Where will the oil price rout end?

It could be $20; even $10! To answer that question, one needs to answer when the supply glut will end. Frankly, not many can hazard a guess at this point of time. Between the US and the OPEC, it is a question of who will blink first. Obviously, OPEC nations in the Middle East have an advantage in that their cost of extracting oil is lower. With huge petro-dollar reserves, the OPEC can afford to hold on much longer.

As far as the US is concerned; as long as it is able to fund its new finds and keep pumping oil, it is ok. The US bets that Saudi and UAE have already started drawing down their dollar reserves and may not sustain much longer. The US also has the exorbitant privilege of a negative correlation between the dollar and crude oil prices. If Fed delays rate hikes beyond September, oil prices may go up again. Crude oil is surely in for interesting times ahead! ©

You can ask us your stock related questions with #AskReligareOnMarkets via our Twitter channel @religareonline

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