Oil Hits New 2018 Low After Tuesday’s Tumble: 3 Reasons Why

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Oil prices tumbled nearly 8 percent on Tuesday, hitting new lows for 2018, with WTI down 40% from highs near $80 per barrel in October.

Oil Hits New 2018 Low After Tuesday's Tumble: 3 Reasons Why

WTI Daily Chart

The drop reflects several ongoing issues in oil markets that include the following:

1. Data indicating significant growth in US oil production

Recent EIA data revealed that oil production in the United States grew even more than previously believed in recent months. In fact, during the last week of November, the US was actually a net exporter of crude oil and petroleum products. The most recent Monthly Statistical Report from API showed that US crude oil production averaged 11.6 million barrels per day in November, making the US the world’s largest oil producer. API’s data for the second week in December also showed a large build in crude oil stores in the US, which in part precipitated oil’s drop. In contrast, the EIA’s weekly report showed a small draw (less than 500,000 bpd) in oil stocks from the US, which probably won’t do much to push oil prices out of their current trough.

The presumption is that despite WTI prices hovering in the $40s and low $50s, oil production from US shale oil regions is an unstoppable juggernaut that will continue unabated into 2019. The truth is that low oil prices aren’t good for US producers, but can be managed if companies hedged smartly back in September; their planned infrastructure improvements come online and companies continue to have access to investment and lines of credit.

Many are focusing on the number of DUCs (oil wells that are drilled but uncompleted) that could quickly be brought online with minimal expense. These DUCs do represent untapped production potential, but it is difficult to accurately quantify how many can and will actually be brought into production in 2019. Although the forecasted production growth for US shale is very robust for 2019, it is important to remember that it requires a confluence of conditions that may not all play out as expected, especially if WTI remains below $55 per barrel for several months.

2. OPEC and Russia’s lackluster production cut

Russia and OPEC did deliver a significant production cut in early December (1.2 million bpd), but this number wasn’t enough to satisfy the market—with good reason. This cut will begin in January and reflects a decrease from OPEC and Russia’s October production numbers. In other words, Saudi Arabia will be shrinking production by about 400,000 bpd and Russia by about 228,000 bpd.

Putting this in context explains why the market has continued to drop despite these plans. EIA data show the United States increased its own oil production by 1 million bpd between June and November, more than obliterating Saudi Arabia and Russia’s planned cut.

3. Demand

All forecasts for 2019 show global demand growth for crude oil slowing. The exact forecasts have been amended multiple times.

The deceleration in demand growth will probably hinge on the degree to which a global economic slowdown materializes in 2019. In the United States, economic activity remains strong despite the falling stock market, and jet fuel demand (a good indicator of economic growth) is still strong and growing.

However, the focus in 2019 will be on emerging economies and whether they experience slower growth. Of course, oil prices in the $40s and $50s could help spur additional economic growth, particularly in those regions.

Note on Saudi Arabia’s 2019 budget and oil policy: Saudi Arabia released its 2019 budget earlier this week. It includes a 7 percent increase in spending. At $295 billion in total, it’s the largest budget the Kingdom has ever posted.

According to financial firm Al Rajhi Capital, the fiscal breakeven for this budget would require Saudi Arabia to sell its oil at $84 per barrel. Bloomberg calculates $95 per barrel. Given where oil prices are today, many analysts are already assuming that, in 2019, Saudi Arabia will take action to push up oil prices in order to balance its budget.

Traders would be ill-advised to take these analyses seriously. Saudi Arabia’s expected deficit is only about 4.6 percent of GDP. It is entirely reasonable for a country like Saudi Arabia to run a deficit rather than tighten spending or force an increase in revenue at this point.

Saudi Arabia still maintains large foreign currency reserves that it can tap into if necessary and it is still able to borrow money. It would be a mistake to assume that Saudi Arabia will aggressively push for higher oil prices in the immediate term based on this budget. The Middle Eastern country is in no rush to balance its budget, as it has at least 70 years of oil in the ground and can pay more attention to debts in future years.

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