With international oil prices plummeting by about 5% overnight, reaching their lowest level in four months. A cold reality lies before oil traders: oil prices have officially entered the technical bear market zone.
Market data shows that the international benchmark Brent crude oil price plummeted 5.2% on Thursday, briefly falling below the $77 mark, setting one of the largest daily declines this year. The latest trading volume in Asia on Friday was around $77.48. The benchmark WTI crude oil in the United States also fell significantly by 5.5% on Thursday to $72.48 per barrel, down more than 20% from its September high - which is also commonly seen as a bear market threshold by technical analysts.
From a technical perspective, while WTI crude oil has fallen into a bear market, it has already fallen below its 200 day moving average. After four consecutive weeks of dips, the signals released from the technical level are undoubtedly extremely unfavorable to bulls.
Why does oil prices continue to decline?
Regarding the overnight sharp drop in oil prices, some industry insiders have stated that the significant weakening of crude oil occurred after the increase in US crude oil inventory data on Wednesday and may have been amplified by automatic selling algorithm programs (programmed trading) - many algorithmic driven traders sold their crude oil holdings when the oil price fell below $80 per barrel.
In fact, although it is not uncommon for oil prices to rise and fall sharply, violent selling with a drop of over 5% like yesterday is still rare on weekdays. In response, Daniel Ghali, senior commodity strategist at Dao Ming Securities, stated that the decline in oil prices may accelerate with multiple selling plans, leading to a vicious cycle.
Ghali estimates that the Commodity Trading Advisor (CTA) may have cleared most of their long positions by the end of Thursday and exacerbated the price decline.
Dutch International Group also pointed out in a research report on Friday that a drop in oil prices below $80 per barrel seems to have brought a considerable amount of technical selling.
Of course, changes in algorithmic programs are ultimately just catalysts for the market. The main downward pressure currently facing the oil market still lies in the many bearish factors on both supply and demand sides. In the past few weeks, concerns that the Palestinian-Israeli conflict may trigger broader regional conflicts and endanger supply in the Middle East have not come true. Despite OPEC and IEA predicting supply shortages in the oil market in the fourth quarter earlier, some key global data this week showed lower demand than predicted.
On a fundamental level, one of the main reasons for the decline in oil prices this week is the sharp increase in US crude oil inventories, while production remains at record levels. Analysts say this has raised concerns about weak demand from the world's largest oil consumer under high production.
The US Energy Information Administration (EIA) released inventory data for the past two weeks on Wednesday. The report shows that US commercial crude oil inventories have climbed from 421.9 million barrels in the week ending October 27 to 435.8 million barrels in the week ending November 3, an increase of 13.9 million barrels. Adding in the 3.6 million barrels added in the past week, the cumulative increase in the two weeks ended November 10th was 17.5 million barrels.
Meanwhile, industry insiders say that China's refining companies, the world's largest crude oil importer, lowered their daily processing volume last month due to weak profit margins.
JPMorgan Chase's Commodity Research Department pointed out on Friday that its global oil demand tracker showed an average daily demand of 101.6 million barrels in the first half of November, 200000 barrels lower than earlier forecasts for that month.
Several US macroeconomic data released on Thursday also generally underperformed - the number of US unemployment benefits has risen to its highest level in nearly two years; The decline in manufacturing output in the United States in October exceeded expectations, mainly reflecting a decline in production activities caused by strikes among automakers and component suppliers.
The form of futures premium is forming
In the context of a phased oversupply situation between supply and demand, the global crude oil market is currently trapped in a futures premium (positive price difference) - that is, the price of near month contracts is lower than the forward price.
Some investors who are not familiar with the oil market may have a similar 'wrong' idea that forward contracts are priced higher than near month contracts. Doesn't that mean people are more optimistic about the future prospects of oil prices? However, in the commodity market, the emergence of futures premiums is not a particularly positive phenomenon at the price level, but often means that the market is facing more downward pressure.
In a 2017 paper, Pimco strategists Nicholas Johnson and Andrew DeWitt mentioned that the shape of oil market futures curves has historically been one of the best indicators for predicting future returns.
They pointed out that, for example, during the spot premium period, oil futures long positions had average returns of 1.3% and 2.9% in the following 4 and 12 weeks, respectively. In contrast, during the futures premium period, the returns on long positions during the same period were -1.7% and -3.8%, respectively.
For most of this year, the oil market has actually been in a spot premium state - indicating that the spot market is tight and end users are scrambling to ensure supply. Previously, Saudi Arabia implemented an additional 1 million barrels per day of production reduction in July, on the basis of OPEC+other member countries' production cuts, fundamentally tightening crude oil supply.
Dow Jones Market Data stated that WTI crude oil has never experienced a sustained term premium since July, until it was completely broken recently.
Macquarie stated that the main culprit behind the current market entering a futures premium state is the increase in low sulfur crude oil production in the United States, North Sea, and Brazil, as well as increasing signs that some oil producing countries have not effectively complied with OPEC+'s production reduction policies. This has led to the current weakness of the oil market and spot prices.
Vikas Dwivedi, a global energy strategist at Macquarie, predicts that this trend will continue until January. He said, "Macquarie not only predicts that WTI contracts will enter a futures premium, but also predicts that some WTI contracts may fall into a significant futures premium state on the curve. This situation is crucial to our belief that oversupply is real, and it does not even require a hard landing or a global recession to bring real demand challenges
Robert Yawger, Executive Director of Mizuho Securities Energy Futures, pointed out that once the price difference exceeds the arbitrage cost (usually hovering around 50 cents per barrel), the futures premium may become a "big problem". Arbitrage costs include storage, transportation, interest, and other expenses.
He wrote that once the futures premium expands to a level higher than the arbitrage cost, large companies that can deliver will buy at the front of the curve (near month contracts), then sell after a month, and automatically earn a profit. He wrote, "When these oil drums pile up in warehouses, they will exert pressure on spot prices, causing bearish market trends to continue
Will OPEC make any major moves next weekend?
All the bearish phenomena in the crude oil market mentioned above undoubtedly put pressure on OPEC+, which is about to hold a ministerial meeting next weekend to discuss future production policies, especially for Saudi Arabia and Russia, which previously insisted on reducing production policies.
Industry insiders pointed out that at the meeting on November 26th, OPEC+member countries will inevitably need to consider how to respond to the weakening of oil prices and concerns about the potential slowdown in global economic growth that may suppress demand.
Daan Struyven, head of oil research at Goldman Sachs, said, "There may be some tests ahead of the OPEC+meeting. In the past, they often announced production cuts or extended production cuts in the $82 to $85 per barrel range. Our current expectation is that Saudi Arabia's production cuts will be fully extended until the first half of next year, but there will be no further cuts in overall oil producing countries
At present, what makes Saudi Arabia and other countries more uncomfortable is that oil supply outside OPEC+countries is continuing to grow, with the United States, Guyana, and Brazil all increasing their oil production.
The Brazilian government has set a goal of becoming the world's fourth largest oil producer by 2029. Guyana, on the other hand, has become one of the fastest growing economies in the world over the past year due to the discovery and extraction of a large number of oil fields.
Edward Gardner, a commodity economist at Capital Economics, said that the production reduction "can only lead to a decrease in OPEC+market share now. These price drops are due to a shift in supply and demand balance. Supply does not seem as tight as expected
The suspense now will lie in whether OPEC+can send a strong signal at the upcoming meeting. I believe Saudi Arabia will demand further production cuts from Kuwait, Iraq, and the United Arab Emirates, but this will be a painful discussion