Oil Prices: Ever Closer To The Brink

Outside US oil markets (because of the midweek Independence Day holiday), the upward bidding war is likely to run one or two, or even 3 or 4 trading days longer. Doing this, oil bulls are certainly shifting the goalposts - they are pushing them to the proverbial cliff face.

Oil has surged in serial killer style for days, starting June 29. It has surged on speculation that central banks from the US, Europe, China and even India and Brazil will ease monetary policy to spur growth. The European debt-and-deficit bailout programs, a now excruciatingly old story, rolls on as the numbers always get bigger and "federal Europe" is rolled out in the Powerpoints if not in reality, but it powerfully aids the task of talking up oil. An even older oil story - Iran nuclear sanctions - wheels itself back on stage from time to time.

After a 9.3% jump on 29 June for WTI, prices gained as much as 4.4% more on 3 July as the European Central Bank is forecast to cut interest rates this week - and has almost zero choice between leaving them on hold, or "slashing" them by 0.25pc. Anything plays for higher oil prices at these moments: Obama's healthcare vote was useful for oil bulls, why that was so isn't too clear. A state-owned newspaper in China said the time is now right to help China's banking sector. Iran fired several 1970s-vintage missiles during a three-day military exercise as oil analysts remembered that Iran has threatened to block tanker traffic in the Strait of Hormuz in reprisal for oil and banking sanctions. Norway's oil workers selectively struck at some North Sea installations. The weather was so bad in Europe heating oil sales might show some unusual demand. Its all good for oil!

The big driver was the easiest to identify. Oil market players, like their equity trading cousins have largely rebuilt their risk appetite, as anticipations of further monetary easing grow, almost worldwide, simply because the economic outlook is so bad, worldwide. For the European oil market players, the playact of threats to market supply, from Iran, are specially put in vogue, this time with the claim that as sanctions against Iran bite, Europe will run short of oil.

LOOKING EAST - AND SOUTH
The People’s Bank of China may cut lending reserve requirements to raise liquidity in the banking system, according to the PRC owned China Securities Journal, published by the official Xinhua News Agency. In a coordinated move, the central bank cut interest rates on June 7, a day after the Journal published a commentary urging the move. Oil analysts focusing this news have totally missed the fast boat to China - weeks of Chinese oil buying as prices fell, and a quick topping up of both commercial and strategic crude oil reserves. As and when, and as long as oil prices rebound, this buying will shut down fast.

The EU27 embargo on Iranian oil took full effect on July 1, supposedly after exemptions on some contracts and oil settlement and insurance operations ended, which on further probing shows is as clear and certain as any European debt bailout, to date. Iran’s crude exports may drop to about 1 million barrels a day, Goldman Sachs said in a 2 July report, depriving global importers of around 1.15 to 1.25 million barrels a day (Mbd) on a June basis. The main problem - here - is that even with Iran out of the market by that amount of oil, the OPEC group is producing oil at record rates, at least 10% over its official maximum collective quota rate, to a most recent estimate of 31.85 Mbd according to the IEA. And crude oil has a way of leaking out and across frontiers.

Iran’s parliament is discussing a bill to close the Strait of Hormuz to oil tankers operating for or linked to countries applying the EU's sanctions, but the real capability of Iran closing the Strait for more than 1 day is low, at best.

Looking at more quantitfied and sure data, US stockpiles decreased slightly last week. Inventories probably dropped 1.75 - 1.9 Mb in the week, according to analysts, but the final data will only come 5 July, from the Energy Department. US gasoline inventories, highly predictably rose last week, by about 1 Mb according to analysts and this trend may continue depsite the start of the traditional "summer driving season", more especially because US gasoline demand is on a long downward slope, and refineries just as traditionally step up operations at that time, from Memorial Day at the end of May to Labor Day in early September.

All kinds of post facto spin can be put on the double-digit jump in oil prices over recent days - but its survival value is low. The big test of credibility is coming, and with only a few drivers able to save the price bulge - probably Iran, possibly the European crisis - the way forward for prices heads South.