Why You Should Be Bearish On Crude Oil

By Steven Knight, Research Analyst for Blackwell Global

The price of crude oil has, yet again, found reason to rally over the past few days, fueled solely by a declining stock of inventories at the Cushing Reserve. The futures market seems to be attempting to price in the diminished supply, along with a potential increase in demand over summer. However, the reality is that the supply imbalance within physical crude stocks is still occurring.

Despite the overarching view that oil fundamentals are improving, US domestic production has still not slowed enough considering the global supply imbalance. A response to the supply imbalance has still been limited mainly to OPEC, with most non-OPEC producers only providing a limited response. In fact, no consensus even exists within OPEC with both Saudi Arabia and Iraq looking to grow production greatly within the near term.

Adding to the continued supply pressure is the fact that debt and equity markets are basically back to normal and open for business, allowing producers to tap into additional capital to grow production. All of these factors are likely to cause the current price trend to reverse and send crude oil prices back towards the $45.00 level.

The reality is that having a bearish sentiment is a little like being a broken wrist watch: you are right at least twice a day. Subsequently, picking the timing for a downturn in prices is problematic, especially heading into a period of increased demand. Also, the elephant in the room is likely the annual fill of China’s SPR. Depending on how demand in the summer season plays out, crude oil may remain above its fundamental level for some time.

However, the market has still failed to correct the global imbalances evident, particularly within Angola and Nigeria. Little has been done to alter the forward imbalances and this provides an interesting fundamental perspective to the commodity. I see an inventory build in the later part of the year as inevitable considering the excess of capital and oil within the market. It is probable that Q3 will see WTI prices retracing to $45/b, before stabilising within the $50 level in the early part of 2016. Obviously, these price forecasts would still fall below the shale industries marginal cost of production.

Ultimately, much of the US domestic price will hinge upon the response of the shale industry to the increased WTI prices. It’s highly probable that the rally will end up being self-defeating, as domestic producers turn up the pumps with the price hovering around the $60.00 mark. Increased rig counts would be the likely sign foreshadowing another significant fall in price. Obviously, if the US repeals the crude oil export ban, then all bets are off.