Even Light Oil is Heavy

The January Brent oil futures contract has broken down in the last 48 hours to approach its late-August lows.  It has fallen a little more than 10% over the past week.  The January light sweet crude contract is also headed south, falling about 12% since the recent high on November 3.  It too has been sold through the October lows.  The late-August low was just below $40.   

The main weight continues to be production in excess of demand.  US output may be around 450k barrels less than the June peak, but inventories are still rising.  API estimated crude stockpiles rose 6.3 mln barrels last week.  The EIA, the official estimate is expected to be somewhat less.,though it recently revised up this year's output forecast.   Meanwhile, news wires have reported that ten Iraqi ships carrying around 19 mln barrels are headed to the US.  This is in addition to the traffic jam of some 40 tankers off the Texas coast. 

The surge of Iraqi oil headed for the US is partly a catch-up after some local issues in October.  Iraq accounted for the bulk of the slippage of OPEC output last month.  According to reports Iraq accounted for 195k cut in output in October, while OPEC as a whole may have seen a 257k barrel slippage.  Iraq's oil problems seems to be resolved.  

OPEC meets on December 4.  Given the Saudi's rhetoric, a cut in quotas is not likely.  What could surprise some observers is that OPEC may increase its quota.  The issue is partly technical.  Indonesia, which suspended its OPEC membership in 2009, has rejoined the cartel.  Due primarily to under-investment in its oil sector, Indonesia is no longer self-sufficient and has to import oil.  Its production last year was about 880k barrels a day.  To make room for Indonesia, OPEC may increase its quota by one mln barrels.  

Seasonally US refineries step up their activity, and this could increase the demand for crude.  However, it may also simply shift the surplus to the products.   If the refinery demand does not support prices of crude, it will be seen as another indication of the glut that looks set to persist. 

Russia's output remains strong, and it looks like it may be setting a post-Soviet era high.  Many observers seem to think Putin has outfoxed the US and Europe, but this may turn out to be a premature conclusion.   Before WWI, the west was the French-German border.  After WWII, it was the west German border.  Now, post-Cold War it is the Baltics.  This is to say the West has moved east.  

Russia's alliance with China is exaggerated.  The central piece of China's development strategy is the "One Belt One Road" which integrates the 'Stans, the underbelly of the former Soviet Union (Kazakhstan, Uzbekistan, Kyrgyzstan, and Turkmenistan).   This is to say the US and Europe have pushed east against Russia.  China is pushing in from the south.   Saudi Arabia has gone for Russia's purse.  

Saudi Arabia is rejecting its traditional role as a swing producer  and has helped push Russia into a recession.  Adding insult to injury, Saudi Arabia is now challenging Russia's oil sales in Europe.  Russia responded quickly to object to Saudi's attempt to encroach on its market share in Europe. 

Falling oil prices will weigh on headline inflation, and there is likely some bleeding into core measures.  In the currency market, over the past 60 days, the Russian ruble and the Canadian dollar are the most sensitive to oil prices (correlations on the percent change basis are 0.75 and 0.55 respectively).   Weak oil prices will continue to discourage investment.  However, as we are argued before, with high fixed costs (which includes debt servicing), companies are incentivized to produce even at a loss.  It will also encourage industry rationalization, which includes failures as well as mergers.  

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