Oil prices: The never-ending problem with cartels

Outlook:

We don’t know how to evaluate turmoil in the oil patch. As noted above, US pro-duction will likely fall by 710,000 million bpd by April next year from the peak of 9.60 million bpd in April 2015, but Iran says it intends to make up more than that. Then there’s Indonesia, which rejoined OPEC last week. Meanwhile, despite the acrimonious OPEC meeting, members pumped more oil in November (230,000 bpd to 31.70 million bpd). Reuters reports “With extra barrels coming from OPEC, the report points to a 860,000-bpd supply surplus in the market next year if the group keeps pumping at November's rate, up from 560,000 bpd indicated in last month's report.”

This is the never-ending problem with cartels—enforcing production quotas. OPEC has never had much luck with it. OPEC currently has a forecast of non-OPEC supply falling by 380,000 bod next year, led by the US and Russia. Reuters reports that last month, OPEC predicted a drop of 130,000 bpd. These numbers do not square up with Williams’ 710,000 drop to April next year in the US alone. And what about demand? “OPEC left its 2016 oil demand growth forecast unchanged, predicting global demand would rise by 1.25 million bpd, marking a slowdown from 1.53 million bpd in 2015.”

In a word, the market is in a mess and OPEC’s numbers are at odds with at least some of the data. What does this mean for FX? If we assume the supply glut continues, we will see rising troubles in emerging markets as well as a distinct absence of inflation by developed country central banks who seek it desper-ately. The trajectory of US rate hikes will be very low indeed.

If the dollar continues to back-pedal from having been overbought, does this mean anything for oil pric-es? We can hardly expect oil to rise just because the dollar is falling—can we? Remember, we long had a supposed inverse correlation between oil and the dollar. See the weekly chart below. In November 2014, the relationship became more pronounced. If we are to get a drop in oil prices to under $30, doesn’t that mean the dollar “should” recover to higher levels, already overbought or not? We really prefer some solid supply/demand information on which to base an oil price forecast, but even the most experienced of energy economists hate to deliver a forecast—the data is too tangled and sen-timent all too often becomes a runaway horse with preposterous “reasons” invented afterwards.

We don’t like the current situation. Old-timers note that the euro breakout is likely a one-time aberration that will subside once the Fed comes into sharper focus next week. Glacial pace notwithstanding, the US is getting normalization and that is likely to have all kinds of so-far unknown effects. One effect already being seen is profit-taking in FX and equities, as well as a pronounced drop in liquidity, perhaps a little early this year because of the timing of the FOMC. In other words, the chart has become less trust-worthy. But if we see the euro drop to under 1.0750, near the midpoint of the breakout bar, and stay there, then we will know it’s a failed breakout—but not before. And no, we don’t expect oil to go up or down depending on the dollar. For the moment at least, supply issues are running the show, even if they are conflicting and messy and not well understood.