Crude Oil- Is the volatility set to drop?

by- Himanshu Gupta- Research Analyst , Metals and Energy Research 

Bloodbath in crude oil prices over past few weeks has sent prices tread water and has traumatized the oil bulls that looked confident for a sustained recovery post the worst sell off in the energy counter after 2008. A notoriously disguised rally that nurtured in the month of March this year from the levels close to $44/barrel at NYMEX and Rs 2700/bbl at MCX helped the prices to gain around 40 % from the lows. It was just the time when the prices caught themselves in an ennui range and bluffed the traders again with the direction of the breakout.

The adolescent rally lost the fizz sooner after the US and Iran signed a landmark deal which led to lifting of sanctions imposed on Iran to export its oil freely. Iran is supposed to dump additional 5, 00,000 bpd into the markets. The market did panic fearing additional supply hitting in an already crammed market. Shrugging off the fact that the complete Iranian oil will reach the market by mid-2016 the prices started to soften. As an old adage goes in the market that bad news does not come alone, the same turned out to be true for oil. Uncertainties over Greece crisis kept the US dollar in high demand leading to sharp gains and as crude oil is priced in US dollar, the rise in US dollar continued to put pressure on oil prices .The increase of rig counts in the US all over again elevated apprehensions of higher supply from the US .On the other hand, Saudi Arabia has started to boost its refining activities leading to higher output in an attempt to clench its market share and if it was not end the latest devaluation of Yuan by China sparked off the import woes by making it costlier .

Most of the above factors crafted the correction in prices all over again and brought them in the vicinity of this year lows. Does it mean that the prices are all set to plunge significantly lower breaking the previous intermediate lows? Or will the oil bulls retaliate and earn a dignified rally here after? Well the answer to this will be discovered in the due course of time itself, but it is worth a word here that the latter scenario cannot be ruled out completely and even if they fail to reverse the entire trend a consolidation looks a high probability scenario.

Huge demand emerging from Asia is capable of supporting the prices. China’s crude oil imports have gained substantially putting the world’s second largest economy in place for overcoming the US as the biggest buyer. China’s oil imports rose to a record high on a monthly basis driven by imports of small, private refineries amid low oil prices. Overseas purchases by China increased to 30.71 million metric tons in July, equivalent to about 7.3 million barrels a day, according to a survey. China’s apparent oil consumption averaged about 10.5 million barrels a day in the first half of the year, 4.8 percent higher from a year earlier. In purchasing more oil than what it needed for its refineries, China has accumulated an implied surplus of roughly 49 million barrels in the first half of this year. China’s appetite for crude is expected to pick up further in the second half of the year as new storage tanks are finished. India at the same time is not very behind; it is now the world’s third largest importer of crude oil after the United States and China. The country’s oil imports have steadied. A decline in rig counts on the back of declining prices is further likely to put brakes on the tumbling prices. It can also lead to EIA reducing its production number in its next monthly production report. The Bureau of Economic Analysis released its advance estimate of real gross domestic product for the second quarter of this year which showed output in the US increasing at a rate of 2.3%. This is a major acceleration from the first quarter when real GDP increased 0.6%, supporting the demand for crude oil.

At the end of the day we have to live with the fact that with the low cost of production, reduced demand outlook and more importantly the dampening confidence, there can be a new equilibrium for the crude oil prices, but post such a selloff the prices look to have found a new equilibrium. The recent selloff looks just a well-timed stroke by the speculators fleeing the prices amidst Chinese equity crash which had hurt the confidence given the low liquidity. The prices might not be able to recover all the losses in immediate future but they look to hit an intermediate bottom if they have not already done so. Going ahead with improving fundamentals, stock revisions and pickup in demand the prices can turn out to be supportive for the prices. Not to forget that post a high voltage selloff, it is not unusual for the prices to sway in a trendless direction for some time like we saw in gold and natural gas down the memory lane. To conclude, the high volatility in the crude oil is not going to entertain the traders forever, while the short term trading opportunities will keep on emerging with the changing macros but this breadth taking volatility looks all set to calm down in near future!

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