Why Dark Days Are Ahead for Crude Oil

pipe line transportation in crude oil refinery

For nearly two years, the global oil market has been flooded with excess supply. Yet, putting a strong bid under crude this year, punters have chosen to ignore this fact.

Brent crude, the international benchmark, has jumped by 64.1% from its low of US$27.83 per barrel on 20 January. It’s trading at US$44.68 per barrel today. West Texas Intermediate (WTI), also known as US crude, has surged to US$43.13 per barrel. It’s up 60.3% from the low of US$26.05 per barrel on 2 February.

Crude’s amazing run started with the hope that major producers would work together to freeze output in February. It didn’t matter that this never happened. Global leaders did their job fantastically, by talking up the price.

Fortunately for crude investors, supply disruptions — such as the Nigerian militant issues and Canadian wildfires — followed. It gave crude the ammunition needed to surge higher.

Today, the reality of the global supply glut has come back to haunt everyone. In my view, crude should hit a new low in the months ahead. If this happens, it won’t bode well for crude investors.

I’ll explain…

Taxes have destroyed demand for crude

To start, forget about everything that you have read on crude lately — it doesn’t matter. The key fact is that supply far outweighs demand.

On the demand side, economies are overleveraged to the point that borrowing more debt is not creating real economic growth. When economies were growing, they needed more crude to feed their economic engines. Today, most of the major economies are declining. Higher taxes and ever-so-burdensome regulation have destroyed the world economy.

When we read the mainstream news these days, it’s rare to find articles talking about businesses expanding and investing their capital. Most businesses are doing the exact opposite. In order to keep their doors open, businesses have had to cut jobs and wages, which have directly hit the economy.

See, with fewer dollars in their pocket, and more in the government’s, consumers are demanding fewer discretionary goods. This is a proverbial punch to the global economy, and spells ‘lower demand’ for crude oil.

On the supply side, a lot more crude keeps being brought to market. Bloomberg reported on the story on Friday (emphasis mine):

Combined inventories held by industrialized nations of all forms of oil — from crude to refined products to natural gas liquids — reached a record of more than 3 billion barrels last month, data from the Paris-based International Energy Agency shows. In the U.S., gasoline stockpiles were at the highest for the time of year since 1984 as record consumption failed to drain the glut refiners created when crude was cheap, according to the Energy Information Administration.

In many ways, the bigger issue is the total inventory overhang,” Amrita Sen, chief oil analyst at consultant Energy Aspects Ltd. in London, said by e-mail. “It is the plight of oil products in particular the light products such as gasoline that is slowing the pace of total stock-draws even as crude stocks fall, and of the eventual re-balancing.”

While the above commentary is useful, a picture can paint a thousand words. Courtesy of Bloomberg, check out the graph below showing crude’s global supply glut on the rise.

Source: International Energy Agency
[Click to enlarge]

Yes, the crude oil price has recovered. But, the recovery has been superficial — the world economy is swimming in way too much crude.

Saudi Arabia, the largest OPEC producer, has increased production to 10.6 million barrels of oil per day; the highest level since 2013. Iraq, the second largest OPEC producer, has increased its oil production from 2.5 million barrels to over three million barrels per day. OPEC has kept increasing production since the start of the year.

At the same time, US oil producers are pumping roughly 8.49 million barrels per day. While this figure is down from 9.5 million barrels per day at the start of the year, things are likely to change.

As I’ve warned for some time, the US shale players plan to drill and produce more wells. For the investment decision to go ahead, most shale producers wanted to see crude hit US$50 per barrel…and stay there for a bit. That happened. Now, according to the Baker Hughes weekly drilling report, the US rig count jumped by 15 last week — the biggest weekly percentage jump since November 2009, and nearly double from the previous week.

Reviewing the story, it really doesn’t look good for crude in the short term. But, things should change in the medium term.

War to turn the crude ship around

Looking around the world, we can see that global tensions are rising sharply. You name it — Ukraine, the South China Sea, and the Middle East — tensions are rising at an alarming rate.

While I’m personally a strong pacifist, I’ve warned that the Third World War has already started. Reuters reported on the most recent disturbing update from the South Chinese Seas:

Freedom of navigation patrols carried out by foreign navies in the South China Sea could end “in disaster”, a senior Chinese admiral has said, a warning to the United States after last week’s ruling against Beijing’s claims in the area.

Speaking behind closed doors at a forum in Beijing on Saturday evening, Sun Jianguo, an admiral and deputy chief of the Joint Staff Department of the powerful Central Military Commission, said the freedom of navigation issue was bogus and one that certain countries repeatedly hyped up.

“When has freedom of navigation in the South China Sea ever been affected? It has not, whether in the past or now, and in the future there won’t be a problem as long as nobody plays tricks,” he said, according to a transcript of his comments seen by Reuters on Monday.

“But China consistently opposes so-called military freedom of navigation, which brings with it a military threat and which challenges and disrespects the international law of the sea,” Sun said.

“This kind of military freedom of navigation is damaging to freedom of navigation in the South China Sea, and it could even play out in a disastrous way,” he added, without elaborating.

Sun also said the court case at The Hague must be used by China’s armed forces to improve its capabilities “so that when push comes to shove, the military can play a decisive role in the last moment to defend our national sovereignty and interests”.

In my view, it is clear that the US wants a war — it’s a declining economic power, which it doesn’t like one bit.

Having considered itself the world’s policeman, the US has poked its nose into every geopolitical event since the Second World War. The difference this time is that China — the world’s second largest economy, and soon to be the largest — won’t be pushed around.

Sun Jianguo’s comments suggest that China realises that war is inevitable in the South Chinese Seas. For this reason, China’s admiral and deputy chief of the Joint Staff Department of the powerful Central Military Commission is preparing for war.

If anything happens in the South China seas, crude oil should sky rocket. Legendary investor Jim Rogers says: ‘War isn’t great for much else but commodities.

If you want to hedge your portfolio against war, buy oil stocks. But not yet. I believe there will be a far better time to buy crude stocks. When the time comes, I’ll let Resource Speculator readers know.

If you aren’t a Resource Speculator reader, I recommend signing up today. You can start by reading the free report, ‘Three “Bounce-Back Mining Belters” to Buy NOW’. Implementing my top-down approach, I’ve found three resource stocks that could make you massive profits in the months ahead.

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Jason Stevenson,
Editor, Resource Speculator

Editor’s Note: This article was originally published in Money Morning.


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