Explanations for the oil crash

Thursday’s dramatic drop in the price of oil and other commodities has left markets reeling.

The rout has continued on Friday morning, and at the time of writing, Brent is down at around $105 a barrel, from about $125 on Monday.

But with no obvious trigger for the sell-off, traders and analysts are offering varying interpretations as to why it is happening, and, especially, why now.

 

The best list of possible reasons comes from JBC energy markets, who offer these (links our own):

-”disappointing global economic headlines” (Platts), referring specifically to an unexpected fall in German industrial orders and the strongest rise in US unemployment since August 2010

-OPEC’s consideration to raise formal quota levels in June

-the death of Osama bin Laden and falling geopolitical risks amid “stabilising tensions” in the Middle East and the end of Nigerian elections

-the end of QE2 in June

-interest rate hikes in India and other Asian countries

-the rise of the dollar amid ECB indications of no imminent further interest rate hike

-the impact of higher fuel and commodity costs

-the general sell-off in commodities, with silver losing 25% of its value since April 25

-George Soros cutting his gold holdings

-a larger-than-expected build in US crude inventories

-a fall by 1.3 million b/d to 18.3 million b/d in US weekly implied demand figures

But they then proceed to dismiss most of these:

There is no way that daily economic data has the power to cut $10 out of oil in one go, as underlined by the fact that the DJIA fell by just 1.1% yesterday.

Currency fluctuations alone could only have been a contributing factor – a similar dollar gain on Apr 18 coincided with a $2.50 decline in oil prices.

Short-term fundamentals are also an odd approach, especially when based on weekly US product supplies, which are well-known to contain errors.

Opec might still have a significant impact on traders’ minds but a possible change of the formal quotas in June is of limited real relevance.

Rather their explanation is simply that a drop like this was due (again, the link is ours):

In the general recovery-backed bull rally, higher price levels were steadily being targeted… All the recent geopolitical issues have provided a steady flow of bullish news, but this has started to ebb recently.

To turn the market around bearish news needs to accumulate and generate a momentum. And most of the factors above have helped the formation of such a bearish momentum, which was also fuelled by the Goldman Sachs comments three weeks ago.

Stephen Schork of the Schork report is blunter in his assessment:

The causes? A sharp recovery in the dollar and a spike in domestic initial jobless claims to 474K, an eight month high.

His currency-led explanation is backed up by Olivier Jakob at Petromatrix:

Our opinion has been that the Euro Dollar was entering a zone where sustainability was at risk due to the strain it creates on the European export economy.

But Jakob also holds to the German data theory:

One of the bearish trigger yesterday was the German manufacturing orders which fell sharply by -4.0% versus expectations of a small increase.

At Reuters, John Kemp pays attention both to George Soros and to increasing talk about demand destruction:

The two most notable developments in the oil markets in recent weeks were (1) the increasing chatter about demand destruction which had displaced the previous emphasis on geopolitical risks and supply constraints as the dominant narrative; and (2) reports that Soros’ fund had started to trim its gold holdings.

To add to competing theories about the causes, there are inevitably disagreements about the direction of oil from here. Kemp sums up the positions:

The narrative about strong demand growth from China and other emerging economies remains intact. Geopolitical risks have receded but have not gone away. Supply growth remains uncertain and potentially costly.

But demand restraint and destruction is occurring, and will accelerate the higher prices go and the long they stay there. As the short-term spike of 2006-2008 becomes a medium-term “permanently high plateau” (to misquote U.S. economist Irving Fisher) alternative sources of supply and new technologies become viable and pose an increasing threat to oil.

Olivier Jakob has another prediction:

What stands out is that equities have not really reacted yet to the big drop in commodities but we do not want to exclude the risk that a correction comes there too following the commodity rout. The move in commodities has been so brutal that it has in our opinion not yet been fully assessed by asset managers and investors.

And he also mentions what seems to be the strangest coincidence of the move:

Today is May 6th, the one year anniversary of the flash crash.

 

 

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