Technical & Fundamental Oil Reports Specialists

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Will Democrats and Republicans now lay down their arms?

Published Monday, December 17th, 2012

What a week we have had. To sum it up in two words: slightly bullish. It was refreshing to see riskier assets gain over the week after a dismal start to the month. Looking at the weekly closing prices the “fiscal cliff” talks clearly hindered US stock markets from posting gains but other developments were more on the positive side. The DJIA index closed 0.15% lower on the week and the S&P 500 index 0.3%. Europe was in better shape with the FTSE-100 index registering a gain of 0.12% over the last 5 days, the Greek stock market 1.94% and the Spanish stock market 2.24%. The deal on European banking supervision supported the euro that closed 1.83% stronger against the dollar. This supported oil with WTI finishing the week nearly 1% higher and Brent just shy of +2%. NYMEX products gained more than 2% last week.

With the exception of Thursday oil prices closed higher every day of the week. The week kicked off with the Italian Prime Minister announcing that he plans to resign after next year’s Italian budget is approved. This weakened the euro and put a lid on any significant rally in oil and share prices. In the course of the week we learnt that German investors are becoming more optimistic on the economy and the Fed announced further quantitative easing and is expected to keep it in place until US unemployment drops to 6.5% from the current 7.7%. European politicians congratulated themselves on agreeing bank supervision – a significant step towards a United States of Europe. Spain and Italy had successful bond auctions and the Chinese flash manufacturing sector PMI expanded. All in all not a bad news week!

Developments in the oil market were less positive with the exception that Chinese oil demand broke above the 10 mbpd mark for the first time ever in November and registered the third highest monthly oil imports at 5.69 mbpd. Apart from the Chinese data we were given a rather bearish set of US weekly stock figures with domestic crude oil production hitting a fresh 18-year high and Cushing stock levels at now less than 1 million bbls below the all-time high. After digesting the latest set of data on the global supply/demand balance from OPEC, the EIA and the IEA it is impossible not to conclude that 2013 looks rather gloomy.

The market has been oversupplied by roughly 1 mbpd in 2012 yet oil prices have remained resilient. For next year the call on OPEC oil will fall to 29.7 mbpd according to OPEC and to 30 mbpd basis consensus forecasts. That makes the current production at close to 31 mbpd excessive if continued. The organisation rolled over its 30 mbpd official quota at last week’s meeting but with no conviction and there is a serious disagreement between Saudi Arabia and Iraq as to who will have to cut production back next year should market conditions warrant. OPEC enters 2013 with plenty of reasons to be concerned.

There have been two significant developments over the weekend which could impact on oil prices this week. The tragedy in Connecticut in which 20 children and 6 adults were shot by a “rogue” gunman could, perhaps, speed up fiscal cliff discussions and encourage Democrats and Republicans to “lay down their arms” and forgo bickering at a time of national mourning. In Japan the LDP have returned to power led by Shinzo Abe promising unlimited monetary easing to devalue the Yen and achieve 2% inflation and a more aggressive stance towards China. We will soon have 3 Central Banks committed to do “whatever it takes” to stimulate growth in their respective economies.

 

A Benign Perfect Storm

Whilst US unemployment plays only a small part in the formation of the WTI price it is worth having a look at this relationship. In the second half of 2008 when oil prices nosedived, US unemployment shot higher from 5% to 10%. Since 2009 the opposite has been taking place. Unemployment has fallen from 10% to 7.7% last month alongside a WTI price increase from below $40 to $87 including a high above $110 last May. See chart below. No surprises. Both oil prices and employment respond in the same way to changes in economic activity and sentiment.

When the Fed introduced QE3 in September they said that they would make $40 billion available each month until there is a sustained fall in US unemployment. They have now announced an increase in monthly bond purchases to $85 billion per month in total and for the first time linked its continuation to achieving an unemployment target of below 6.5%. If unemployment falls to 6.5% where will the WTI price be? A lot higher is the logical answer. The last time the US unemployment rate stood at just above 6% (August 2008) WTI was well over $100. Of course, oil prices are affected by a myriad of other factors but as a rule of thumb one can conclude that the healthier industry and the more people are employed the greater energy demand, supporting prices.

It is normal that there should be positive correlation between US employment and oil prices, but the exciting prospect for next year is that there could be a disconnect. Low energy prices should kickstart US industry and employment but, because of the perfect “storm” of ever increasing US domestic production and an inland off-take capacity that cannot keep up, oil prices may remain moderate. A perfect storm that for once delivers sunshine rather than rain?

 

 

 

 

 

Posted by Tamas Varga

Tamas Varga has been in the oil industry since 1992 and with PVM for 18 years. During his time in the industry he has gathered a range of experience in the oil markets. At PVM Tamas is in charge of data collection and analysis.