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Energy bears were reawakened in the kick off of 2016 after Wednesday’s feeding frenzy in the crude oil futures market sent prices plunging to fresh lows, breaking the $35/barrel level.
Amid a flurry of new disappointing developments on both the supply and demand side in just a few short days, downward price pressures in the oil futures market are showing no signs of easing up.
Crude Oil Prices Break Below $35 a Barrel
Oil futures plunged to levels not seen in over a decade on January 6, 2016 in light of several fundamental factors colliding to form a perfect storm (more on that below). The pain in the energy market has only worsened much to the bulls’ frustrations:
Over the past two months alone (11/9/15-1/6/16), crude oil futures (black line) and the oil ETF (USO ) have shed over 25% each, with the latter leading to the downside. The early price action we’ve seen thus far in the new year may very well be setting the stage for a third year in the oil bear market saga.
What’s Behind the Plunge?
Let’s examine the fundamental price drivers responsible for oil’s most recent leg-lower.
On the supply side:
- Diplomacy gone sour between Saudi Arabia and Iran over the weekend has cast a great cloud of uncertainty that the already merciless OPEC would come to agreement with regards to cutting back on production.
- The EIA released its weekly petroleum status report on Wednesday morning and traders were greeted with more news of growing production (this time at home), which only added to the oversupply pressures already facing the oil market.
On the demand side:
- China, the world’s largest net importer of oil, posted another round of worse-than-expected economic data after a weak services sector reading sent slowing oil demand fears across the market. This release only magnified the negative manufacturing data seen on Monday which helped spark the global equity market sell-off.
- Lackluster factory orders and ISM non manufacturing data releases on the home front the same day didn’t help on the demand side one bit.
And last but not least, let’s not forget about the U.S. dollar remaining stubbornly strong, which only adds to the price pressures facing crude oil.
When we consider all of the above, it’s no mystery that crude oil prices remain under strenuous pressure, and will likely remain volatile, given the persistent fundamental headwinds at hand.
Crude Oil Outlook
Where do we go from here? We all know that markets are cyclical, but the painful phases can often outlast our patience and risk tolerance. Put another way – the market can remain irrational longer than you can remain solvent.
Who really knows how long it might take for oil to bottom, let alone begin to rebound for real – and even assuming that it does, what’s to say we’ll see the same level of demand ever again in light of growing adoption of alternative energy sources in every aspect of our lives, all around the world.
One expert that got it right in 2015 is predicting a rough road ahead for oil prices this year again. Tom Kloza, founder and global head of energy analysis at data provider Oil Price Information Service expects for WTI futures prices to hit $32 a barrel in 2016; he also believes that a recovery to $55/barrel is also potentially in the cards in his eyes.
Ways to Play
Investors can play the oil market in a number of ways, including commodity as well as equity-based funds:
Traders can get very granular with their product selection on the equity side:
The Bottom Line
The last time I wrote about oil was on December 8, 2015 following a plunge to fresh lows. My conclusion then carries over to this scenario quite perfectly: the biggest factors at work driving oil prices lower aren’t showing signs of reversing yet, so be careful with “bargain priced” buys in the energy sector right now.
Follow me @SBojinov
Image courtesy of suwatpo at FreeDigitalPhotos.net
