Recent tepid economic data worldwide and US oil inventory build could combine to create an oversupply situation not unlike that experienced during the 2014 oil rout

by MARK RAO / pic by BLOOMBERG

Crude oil prices could be headed for a major correction as the realisation of a global economic recession derails the energy market, while demand falls.

Tighter oil supply backed by OPEC helped both Brent and West Texas Intermediate (WTI) oil contracts rally 37% and 46% respectively since Dec 24 last year.

However, recent tepid economic data worldwide and US oil inventory build could combine to create an oversupply situation not unlike that experienced during the 2014 oil rout.

Oanda Corp senior market analyst Jeffrey Halley said sentiment drove oil prices higher recently, especially on expectations of a US-China trade deal, as well as manufacturing data worldwide exceeding expectations.

“With equity and energy markets focusing solely on positive news, and ignoring data such as the huge increase in US crude inventories (on Wednesday), we have seen an extended series of up days, leaving the technical picture very overbought,” he told The Malaysian Reserve (TMR).

He said near-term catalysts for a correction could come in the form of poor US non-farm payroll numbers or an inconclusive end to US-China trade talks which are in the final round of negotiations.

Until then, Halley said the longer oil stays overbought on a day-to-day basis, the more severe the correction will be for both the Brent and WTI contracts.

Crude oil prices historically contract between 5% and 10% in a short period after prolonged overbought conditions.

A decline to 2014 crisis levels would require sustained evidence that a comprehensive global slowdown is underway, Halley said.

FXTM global head of currency strategy and market research Jameel Ahmad said Brent oil remains well-supported above the US$60 (RM246) per barrel level on output cuts from OPEC and partners, as well as continued demand.

He said markets must remain vigilant in monitoring global economic conditions as a recession could cause oil to repeat its fourth quarter of 2018 performance (4Q18). The Brent contract declined 36% over that quarter to close at US$53.80 per barrel.

“Further signs of deterioration could send investors seeking shelter in the US dollar, which would then inversely affect oil prices,” he told TMR. “Should a recession indeed materialise as predicted, that could see Brent futures unwinding its gains and repeat its steep decline as it did in 4Q18.”

He added that the key caveats to a bullish oil outlook is US shale output and waning global demand.

“Should shale producers maintain production at near-record levels as global economic conditions show further signs of deterioration, that could upend attempts to rebalance the oil markets and weigh negatively on oil prices,” Halley said.

While OPEC and its major partners control about 55% of global oil supply, the recent US inventory build of 7.2 million barrels for the week ended March 29 is posing a threat to their ability to control the market.

A decline in oil prices to the US$50 per barrel mark would be significant for Malaysia, whose government budgeted for an average crude oil price of US$70 per barrel in 2019.

As a net exporter of oil, Malaysia stands to lose between RM3.6 billion and RM6.6 billion in revenue if oil prices trend between US$50 and US$60 per barrel — no small loss given the nation’s over RM1 trillion debt.

Finance Minister Lim Guan Eng said the federal government will only re-calibrate its budget if average crude oil prices dip below US$50 per barrel.

Local listed oil and gas (O&G) players have also benefitted from the crude oil rally in 2019 as Petroliam Nasional Bhd (Petronas) is allocating higher capital expenditure on the improving industry outlook.

Affin Hwang Investment Bank Bhd has five ‘Buy’ recommendations of the 12 O&G counters covered by the research firm, namely Petronas Chemicals Group Bhd, Serba Dinamik Holdings Bhd, Velesto Energy Bhd, Bumi Armada Bhd and Kelington Group Bhd.

A major correction in crude oil prices would be cause for pause for Petronas and could see the national energy company cut back on spending to the detriment of local O&G firms who are dependent on the former for work.

As it stands, Petronas is planning for RM15 billion in upstream spending domestically in 2019, where the bulk of Malaysian O&G players operate in.