How Financial Engineering Wreaks Havoc on the Price of Oil

The financial aspects of oil overwhelm the fundamentals and deliver counter-intuitive price action.

Dan Dicker, Oil & Energy Insider, the premium publication.

There’s been some agreement inside the analyst community on oil – $70 a barrel is not sustainable, in that several producers don’t have the prime acreage or debt positions to survive. The number of requests for rig permits is already dropping, capital expenditures are being slashed and production growth will significantly slow, if not reverse in the next six months. Knowing all this, why can’t crude oil rally?

Because of the vagaries of financial oil markets.

Again and again, I try to show how the financial aspects of oil overwhelm the fundamentals and play havoc with them, delivering counter-intuitive price action.  Charting the money flows into oil will show why the oil market is destined to stay low for an extended period of time, even perhaps after the glut begins to clear and US oil production starts to drop.

All of these reasons have nothing to do with supply or demand and are entirely financial – but describe why oil will continue to be weak for the next six months.

1 – E+P panic:  Oil companies trying to avoid default risk are more apt to hedge oil futures at $65 than they are at $75 – even though these hedges are below breakeven prices for many of them, they mitigate the immediate risk of bankruptcy should oil go down to $50 a barrel.  This is a market that breeds selling as it goes lower.

2 – Investment Bank marketing arms gone:  One of the results of IB marketing of alternative assets was a continued supply of retail buyers into the commodity space, particularly oil. Much of that ‘bid’ is gone now as US investment banks have given up on their trading desks in oil and other hard commodities.

3 – Passive commodity index funds are leaving:  An incredible commodity deflation including oil, base metals and grains has forced passive indexers of commodities into sell mode. The redemptions on passive indexes are at a level not seen since 2008.

4 – No good retail thesis to buy oil:  Where you could make a case that commodity inflation had to accompany growth in the US before, you can’t make it now.  Further, while geopolitical unrest in the Middle East and Russia were terrific incentives to bet on supply shortages in the last 10 years, the markets are suddenly entirely unimpressed with them today.

5 – The Dollar remains strong: With every Asian and EU nation chasing devaluation, the dollar will continue to show strength, adding pressure to oil prices.

Combine these five factors and you’ve got little reason to expect an oil rally in the near future. In fact, I’m looking now for truly bullish hard numbers to reappear to finally inspire any new bid in the oil markets. That might include a real drop in US production in shale for the 1st quarter of 2015, a few mergers or outright bankruptcies of smaller US E+P companies, and perhaps an indication that Euro Central bank easing is adding support to EU markets. It wouldn’t hurt to see gasoline demand increase from lower prices as well – an even bigger upswing in truck sales would be a good initial sign of that.

Those indications are, I believe, at least 5 months away. Until then, expect a continued low oil price, where every rally, no matter how small, needs to be sold. Dan Dicker, Oil & Energy Insider

With $9 billion in debt and no profit in its entire history, US LNG “exporter” Cheniere is priced as if the future is not just rosy, but guaranteed, and that is not the case. Read…  Cheniere’s Big Gamble With Other People’s Money

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