Why I Don't Trust the Bounce in Oil

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Like a lot of people who follow the energy markets, I have on several occasions taken a stab at finding a bottom for oil. Logic dictates that at some point, the commodity will recover and the potential long-term rewards of being on the right side of that move when it comes makes it worth a couple of false starts. At first glance the jump in WTI over the last couple of days made it look as if we may have found a bottom, but unfortunately when this latest move is analyzed, it doesn’t look sustainable.

I have said many time in these pages that in the short-term market positioning and sentiment will trump everything, including both technical and even fundamental factors that drive price. That was evident in the price action in WTI futures yesterday. There was a huge surge in oil following the inventory numbers; a move that made little sense considering the actual figures. U.S. oil inventories rose by around 4 million barrels last week, significantly more than the 2.4 million barrel original forecast. That, along with the fact that production remained stubbornly high at 9.2 million barrels a day, should have been a bearish report but instead oil posted its biggest one-day gain in months.

The only logical reason for that was that it was a relief rally of epic proportions. The day before the official numbers the API had published their estimate, which called for a 4.6 million barrel build. Relieved that that wasn’t the case, traders piled in, presumably squeezing some shorts out of their positions in the process. In the long term, though, “not as bad as it could have been” is not a sustainable reason for a rally. Eventually the fact that U.S. and indeed global production is still outstripping demand is what matters.

That is what will have to change if we are to see a real bottom, and for now that isn’t the case. Most commentators, including me, had expected the situation in the U.S. to have changed by now as low prices forced the closure of wells and in some cases, bankruptcy among exploration and production (E&P) companies. Those closures, however, have been slow in coming. What is different this time is that the smaller companies, faced with the need to service debt have, far from cutting back, actually increased production to compensate for lower oil.

That has been facilitated by banks operating on the principle that, as I heard in a recent NPR report, “A rolling loan gathers no loss.” The realities of the post-financial crisis world and increased regulation mean that that can only go so far, however. Eventually U.S. production numbers will decline significantly, but that hasn’t happened yet.

From a global perspective, too, there is still an oversupply of oil. The latest IEA report, released earlier this week, indicated that global supply outstripped demand by 390,000 barrels a day in Q4 2015. The good news there was that demand still increased by over 1% on a year on year basis, but it should be borne in mind that those figures were before the Iranian oil came onto the market. Even though worries about China are said to have sparked the latest declines in oil, this looks like a supply story, and until that is under control, fundamental conditions don’t support a sustained rally.

With all of that said, things are changing, albeit slower than most anticipated. Supply is beginning to slow, or at least it has stopped growing rapidly, and demand is still increasing. That would suggest that we are close to the bottom, and somewhere in the mid $20s for WTI still looks like it could be the level. The jump over the last couple of days, however, is more about trading dynamics than fundamentals and as such it means little in the long term.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Martin Tillier

Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.

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