For every oil market action, there is usually a corresponding oil overreaction by both oil producers and oil consumers.
While oil prices fell just short of my $80 a barrel target in 2018, looking ahead to the New Year that target should be met and even exceeded in 2019. Oil prices were knocking on the door of that lofty target amid record demand and fears that impending sanctions on Iranian oil would leave the market undersupplied. In response to the promise by President Donald Trump to reduce Iranian exports to zero, OPEC raised oil production and U.S. oil producers moved to ramp up production.
But just as the sanctions were supposed to go into effect November 4, the President granted waivers to Iran’s biggest oil buyers causing a short-term oversupply situation and ultimately a run on the oil bank. Now, normally oil might have been able to recover from President Trump’s sleight of hand. But not this time, because the sharp drop in oil prices seemed to spark fear about the overall health of the global economy.
Coming off the rails?
Many times, a drop in the price of oil sparks warning signals that something is amiss in the global economy, and worries about a trade war, rising interest rates and a government shutdown mixed in all led to a fear that everything would soon come off the rails. The sharp drop in the oil price is one reason many people lost faith in the stock market, because if oil was floundering so too must everything else.
Oh sure, there were fears of a slowing economy in China and in Europe, but if you look at the number of barrels imported and consumed, from an oil standpoint any slowdown was negligible. In fact, in the U.S. demand for total oil products is at an all-time high.
Yet in oil, and in markets in general, it is perception and not necessarily reality that drives prices. Yet, that being the case, for every major oil action you will get that oil overreaction that will leave the market undersupplied in the New Year.
The overreaction started with OPEC. In response to the drop in price they agreed, along with their “co-conspirators” Russia, to cut output by 1.2 million barrels in January. Even Alberta Canada joined in cuts, subtracting 325,000 barrels of oil a day. Yet because the market was unimpressed, you now are hearing rumblings that OPEC and Russia may agree to a larger cut to stabilize an oil market that was leading stocks lower and now following stocks that have been seeing unprecedented moves.
The move lower is also causing many oil companies to cut back spending by reducing their output in the New Year. In the shale patch already, there is talk of potential bankruptcies and big capital spending pullbacks. The Houston Chronicle reported that Eagle Ford, shale’s third largest driller, shows signs of distress. “Sanchez Energy made it through the two-year oil bust that roughly ended in 2016. But now, despite a year of mostly rising crude prices, the Houston oil and gas company is showing signs of distress that in a worst-case scenario could land it in bankruptcy,” the report said. This came after Parker Drilling filed bankruptcy earlier this month.
We should see more pain for U.S. producers, and most will be forced to scale back drilling in the New Year. That will reduce the expectations for U.S. oil from producers that are coming off a record production year. According to the Energy Information Administration, U.S. production hit a record 10.88 million barrels per day, ending 2018 as the world’s top producer. Output this year was forecast to rise 1.53 million bpd, down from the EIA’s previous estimate of an increase of 1.55 million bpd. But we may have to see those projections lowered again as the market is in an overreaction mode.
Yet I believe that the market is overpricing in the slowdown. The government shutdown won’t have a lasting impact on oil, and I think we will see a deal with China on the trade war front in 2019. The Fed should be done with interest rate hikes and the U.S. consumer is loving low gas prices. So, enjoy it because for every action in oil, the overreaction is going to get you.
Happy New Year!
Phil Flynn is senior energy analyst at The PRICE Futures Group and a Fox Business Network contributor. He is one of the world's leading market analysts, providing individual investors, professional traders, and institutions with up-to-the-minute investment and risk management insight into global petroleum, gasoline, and energy markets. His precise and timely forecasts have come to be in great demand by industry and media worldwide and his impressive career goes back almost three decades, gaining attention with his market calls and energetic personality as writer of The Energy Report.