Oil prices appear to have completely lost any foothold on Tuesday, collapsing by almost 7%, while there seemingly was no universal trigger for the sell-off like EIA reports, OPEC statement or news on cuts of oil imports. There was a mysterious synchronous reassessment of the prospects for demand or supply which certainly doesn’t bode well for the market future.

It is important to attempt to make a conclusion about which of the fundamental forces led to the loss of equilibrium in the market, because it will have different consequences for other assets and will form a profile of market sensitivity to certain signals. If there are concerns about the slowdown in consumption among major oil importers, it seems reasonable to pay attention to the prospects for their economic growth. Indeed, the development of underlying trends in China’s economic data resembles emergency braking of the economy, taking the recent decline in exports, imports and manufacturing activity. However, distancing from macroeconomic figures, specific data on oil imports indicate a record increase in November – up to 10.43 million barrels per day. In annual terms, growth was 8.5%. And after Trump’s meeting with Xi in Argentina, Chinese refineries resumed oil purchases from American suppliers.

South Korea’s customs data for November showed that the country had not purchased Iranian oil in the previous three months, following US sanctions against Iran. Later, the United States gave some countries the opportunity to resume energy purchases from Iran, however, as shown by South Korea data, they did not rush to do so, citing lack of insurance for transportation and other problems. The plans of the largest consumer of Iranian oil in South Korea, SK Innovation Corporation are to resume accepting Iranian tankers by mid-January.

The substitution of Iranian barrels occurs through an increase in purchases from the main supplier – Saudi Arabia. South Korea increased demand for Middle Eastern oil by 16.6% yoy. In general, oil imports decreased by 1.6% compared to the same period last year, primarily due to lower demand for Iranian oil.

Japanese imports of crude oil in November also exceeded expectations despite negative GDP growth, contributing significantly to the increase in total imports over the past month (12.5% in annual terms).

Fuji Co, one of the major Japanese oil consumers in Iran, plans to resume purchases in January, including condensate. A company spokesman said that Iranian prices are fine with them, so the country will probably remain on the list of key suppliers. However, purchases may be suspended again in March, as the government must extend the insurance of cargo ships for the next fiscal year, and this will happen only on April 1. Uncertainty in the demand for oil in Japan, as can be seen, is centered around relations with Iran, while the overall potential for consumption still remains high.

The latest data point to an increase in energy demand in the Asian region, which is why it is difficult to justify pressure on prices by a shortage of buyers. There is a definite outlook for decline in demand, but it will happen in the next year, i.e. for now it’s a latent fundamental driver for decline in prices.

Consequently, the reason for the fall in prices should be sought in the issue of overproduction. The planned cuts in drilling by Saudi Arabia and Russia by almost 1.2 million barrels failed to become a solid ground for leading expectations of market rebalancing and price growth, as there are doubts about how quickly and consistently the parties part of the agreement will limit production. The latest EIA data showed that the United States surpassed Russia and Saudi Arabia at production volume (11.7 million b / d), thus gaining energy independence and even approaching the status of net exporter of oil. Oil production in the Russian Federation, a key player in the global oil alliance, reached 11.4 million b / d in December, which hardly resembles readiness to reduce production.

The number of wells drilled in the Permian Basin and New Mexico rose by 238 to 4039. In trade hub Midland, Texas, oil is already being offered for less than $39 a barrel. In light of the significant oversupply of oil in the United States, the production curbs by OPEC countries and Russia becomes uneconomic and ineffective, as American producers will willingly fill the released demand.

The flooding of the market with American barrels has so far been holding back export capacities across the ocean, so for now the surplus will accumulate in the ports of Houston and Corpus Christi.

According to the EIA, by the end of 2019, the total US output will reach 17.4 million barrels, while oil imports will drop to 320 thousand barrels, the minimum level since 1949.

The futures curve again went into contango, indicating a strong glut on the spot market:

In early 2017, Saudi Oil Minister Al-Falikh said that the decline in production in response to structural shifts in supply was largely ineffective. The kingdom will be able to make “one-time adjustments in production,” otherwise, the free market would govern pricing.

Now Saudi Arabia is facing a challenge similar to the situation in 2014. And if you take the words of Al-Falikh as the basis of the kingdom’s market struggle strategy, prices are doomed to further decline, because American producers are certainly not going to retreat.

Please note that this material is provided for informational purposes only and should not be considered as investment advice. Trading in the financial markets is very risky.

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Oil prices appear to have completely lost any foothold on Tuesday, collapsing by almost 7%, while there seemingly was no universal trigger for the sell-off like EIA reports, OPEC statement or news on cuts of oil imports. There was a mysterious synchronous reassessment of the prospects for demand or...