Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

The big question in the oil market is whether OPEC and chums will extend their supply cuts when they meet later this month. Except, it's actually a foregone conclusion that they will (see this).

The real question is this: Will they also deepen the cuts?

Brent crude oil dropped below $50 a barrel on Thursday for the first time since late March. If it closes below that level, it'll be the first time since November 29 -- just before the supply cuts were announced.

That's freighted with symbolism. But the more telling price move concerns the "strip" -- the average price for the first 12 months of futures contracts. Here is how that looks for both Brent and Nymex light, sweet crude:

Remember November?
The Nymex and Brent oil strips have just dropped below their pre-supply cut levels
Source: Bloomberg
Note: 12-month futures strips.

U.S. oil production is rising, as a mixture of efficiency gains and open capital markets has enabled many E&P firms to keep pumping at lower prices. Indeed, energy economist Phil Verleger points out that open interest in Brent and WTI futures for the next 12 months jumped by the equivalent of 13 million barrels on Wednesday. He suspects that reflects producers rushing to hedge future output -- and all that selling weighs on prices.

The initial burst of bullishness fostered by OPEC has, of course, played a big part in the shale revival. So cutting more of the organization's own output to juice prices would come with the negative side effect of helping its rivals.

And there's another side effect OPEC should worry about, too.

Because oil isn't the only commodity falling: Copper, iron ore, nickel and steel prices -- along with the stocks of the metal and mining companies that produce them -- are all slumping on fears about Chinese demand amid a crackdown on excessive borrowing.

Demand is the bit of the supply-and-demand balance that tends to get forgotten when all the attention is focused on the utterances of OPEC member ministers. But the market can't ignore bearish signals forever. Besides the slide in metal markets, a few other recent ones include:

  • Gasoline demand in the U.S. has been unexpectedly weak, and inventories, particularly on the East Coast, are well above average as refiners have taken advantage of low crude oil prices to boost production;
  • New vehicle sales have stalled in the U.S., with implications for jobs, consumer demand and steel producers, among other things;
  • All is not well in the used car market;
  • The initial estimate for U.S. GDP growth came in below 1 percent for the first quarter.

A curious thing that has happened over roughly the same time frame as the supply-cut drama is the rise in market optimism following the U.S. presidential election. The Conference Board Consumer Confidence index jumped from around 100 in October to 125 in March, its highest reading since 2000. Stocks and commodities did likewise.

However, in the latest reading, for April, confidence fell. One notable aspect: The index for future expectations fell more sharply than sentiment about the current situation. As Carl Riccadonna, Chief U.S. Economist at Bloomberg Intelligence, wrote last week:

The more pronounced weakness for expectations may be a reflection of rising doubts toward the Trump agenda against the backdrop of relatively solid economic conditions. Forecasters will no doubt watch to see if ebullience continues to fade in the months ahead, as they attempt to assess whether the “Trump-bump” to sentiment will have a sustained impact on economic conditions.

What OPEC faces, therefore, is not merely a loss of faith in its ability to rebalance the oil market. It must also deal with signs of fatigue in sentiment, economic activity and, ultimately, demand.

So at this point, extending the existing supply cuts is merely necessary to prevent an utter rout in oil prices. OPEC would have to deepen the cuts to really jolt the bulls back to life and scare off the bears. And yet, doing that would of course also put more rigs back to work in Texas and more pressure on consumers.

That conundrum won't go away, whatever OPEC & Co. choose to do.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in New York at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net