Kristian Rouz — Global oil prices declined during the past several weeks, stemming from the rise in US crude inventories and sluggish demand for energy. This encouraged oil bears and triggered a flight of investment capital from US energy stocks into Treasury bonds. While US drillers are counting losses, the rise in government bond value has added to the compression of the US Treasury yield curve, initially inspired by the Federal Reserve's rate hikes.
Subsequently, these developments are driving the demand for safe haven assets yet again, and an increasing number of market participants are becoming more skeptical about US economic prospects.
The S&P 500 Energy Index has declined 14 percent this year, mainly because the US oil benchmark, West Texas Intermediate, has slumped 19 percent. US oil had risen to as high as $54.45/bbl in February, but the drillers, encouraged by the higher prices, boosted output, and are now counting losses to their stock capitalization.
The recent developments in the oil market have completely erased all the positive effects to energy that the OPEC output caps had had, and are putting into doubt OPEC's ability to affect the global crude market to any substantial degree.
"The lack of a positive response in oil prices clearly suggests market participants are not convinced that OPEC's efforts will help shore up prices in a meaningful way in the short-term as shale supply continues to rise in the US," Fawad Razaqzada of Forex.com said. "Unless we see a marked reduction in crude stockpiles, the possibility of further short-term falls in the price of oil cannot be ruled out."
Aside from the US shale drillers, other global oil producers, such as Russia, Iraq, and Saudi Arabia, have also increased their output recently, contributing to the accumulation of the international oil supply. Meanwhile the demand for energy remains subdued due to sluggish economic growth and fragile manufacturing in the world's largest economies.
Oil inventories have risen to their January levels of roughly 100 mln bbl of oil held in sea storage currently, compared to the stockpile lows of 80 mln bbl in mid-April. Another problem is, while in the US alone, crude stockpiles fell by 2.72 mln bbl last week, petrol inventories rose by 346,000 bbl due to the high processing capacity of the US refiners, and a low consumer demand for petrol amid the low purchasing power of the US households.
Most market participants are confident that either the OPEC cuts did not work in the face of heightened North American production, or the extension of the OPEC cuts will take time to take effect, potentially coinciding with a near-term pickup in global demand for energy.
"People are getting a little fatigued waiting for the production cuts to have effect," Michael Lynch of Winchester, MA-based Strategic Energy & Economic Research said. Market participants appear to be "very nervous about the near-term prospects."
That said, the oil market dynamics are hardly encouraging for short-term investment, and are affecting US economic growth. Lower energy prices might stir disinflationary dynamics in the advanced economies, but as of now, the flattening US Treasury yield curve remains a factor to be closely watched until the White House takes action.
