Crude bulls, stung by the worst July on record, should expect further pain as slumping commodity currencies cut production costs.
Drillers from Russia to Canada, the world’s second- and fourth-biggest oil producers, sell crude in US dollars while paying most operating costs in local currencies. The Canadian dollar dropped to an 11-year low against its United States counterpart this month, while the Russian rouble trades near a six-month low.
Global oil supply has proven resilient. A 60 per cent decline in US dollar prices since June 2014 has not curbed US production, which is near the highest level in four decades.
Iraq is producing at a record pace and Russian oil output reached a post-Soviet high this year. The world’s oil glut will last through the next year, the International Energy Agency said in a on August 12.
“The cross-commodity downdraft led by oil, gold and copper has hit producer currencies hard,” said Mike Wittner, the head of oil market research at Société Générale in New York. “The weaker their currencies get versus the dollar, the lower their costs. This further weighs on commodity prices and just adds to the negative spiral.”
Commodity currencies have been the worst performers in a Bloomberg ranking of major world currencies this year as raw material prices collapsed and the US Federal Reserve inched towards its first rate increase in almost a decade. The Brazilian real, New Zealand dollar and the loonie, as the Canadian dollar is known, have led declines against the US dollar.
Bear markets
The Bloomberg Commodity Index of 22 raw materials has declined 29 per cent since last August, meeting the common definition of a bear market, which is a 20 per cent drop. The loonie has also taken a hit from drops in iron, aluminium and gold. Russia is the world’s biggest exporter of natural gas and a major producer of gold and coal.
“Divergence in currencies suggests a stronger dollar, weaker commodity currencies and hence lower production costs,” said Jeff Currie, the New York-based head of commodities research for Goldman Sachs.
West Texas Intermediate (WTI) was at $42.37 on Wednesday, after settling at the lowest since March 2009 on Monday. Brent crude was $48.83.
Oil prices are experiencing a “double dip” and could extend losses for another 18 months, according to a Bank of America report dated July 24. Mr Wittner of Société Générale cut his third-quarter WTI forecast by $12.20 to $47.80 a barrel, and 2016 by $5 to $55 in a report dated August 6. He reduced third-quarter Brent by $11.90 to $53.10 and 2016 by $5 to $60.
Canadian costs
A one-cent decrease in the Canadian dollar bolsters cash flow for Canadian Natural Resources, the nation’s largest heavy oil producer, by C$55 million (Dh155m) to C$60m, the chief financial officer Corey Bieber said.
Per-barrel production costs for Canadian oil producers have fallen about 20 per cent from a year ago, helped by the exchange rate, and some of the savings will last, said Kyle Preston, an analyst at National Bank Financial in Calgary.
“It’s setting the industry to be a lot leaner going into a potential recovery,” Mr Preston said. Canadian crude production is poised to rise 4 per cent this year, according to the Canadian Association of Petroleum Producers.
The risks to Russia’s economy triggered by the slide in oil prices will be mitigated by the decline in the rouble, Vladimir Osakovskiy, the chief Russia economist at Bank of America in Moscow, said in July.
Rosneft gains
Rosneft, the world’s largest traded oil producer, increased drilling by 27 per cent in the first seven months of the year, the company said last Thursday. The nation’s exports remain just as profitable as they were a year ago when the oil price was about $100, according to Citigroup.
A US rate gain, possible as early as September, would bolster the dollar and reduce the appeal of commodities priced in the American currency as a store of value. Futures show a 48 per cent chance the Fed will raise borrowing costs at its next meeting on September 16 to 17.
“When the Fed raises rates, it’s inevitable that the dollar will rise and oil will fall,” said Michael Corcelli, the chief investment officer of hedge fund Alexander Alternative Capital in Miami. “It’s not only the dollar that’s weighing oil, it’s also excess supply.”
Meanwhile, after showing some short-lived optimism, hedge funds resumed their retreat from the US oil market, cutting bullish positions for the seventh time in eight weeks as prices dropped to the lowest since 2009.
Money managers’ net-long position in WTI crude declined 11 per cent in the week ended August 11, US Commodity Futures Trading Commission (CFTC) data show. Short positions climbed to the highest level since March, a signal speculators see prices continuing to fall.
Futures markets this summer have plunged the most since trading began in 1984, as the US enters a period in which refinery demand usually falls.
“The consensus view is that we’ve got further to fall,” said Tim Evans, an energy analyst at Citi Futures Perspective in New York. “The market is in what looks like a persistent supply-demand surplus and that will put downwards pressure on prices, possibly through the end of 2016.”
WTI, which is down 30 per cent since the start of June, should come under renewed pressure when US refineries perform maintenance next month, said Mr Corcelli.
Seasonal drop
Refiners cut operating rates during September in nine of the past 10 years and petrol demand sank each year, the US Energy Information Administration data show.
“The summer driving season is pretty much gone and we’re now looking ahead to a lull in demand,” Mr Corcelli said. “Prices probably won’t continue to crash, but they should grind lower.”
Speculators last week increased bullish bets on US oil, a move that came too early in a market that continues to slide.
Iraq’s production rose to an all-time high of 4.18 million barrels per day in July, which helped Opec maintain output. Iran may add to the surplus after reaching a nuclear agreement last month.
The number of active oil rigs in the US increased for the sixth time in seven weeks, Baker Hughes data showed. The return may slow a decline in production as the nation’s crude stockpiles are almost 100 million barrels above the five-year average.
Stronger dollar
A stronger dollar is also weighing on futures, after China devalued the yuan. A weaker Chinese currency may hurt demand in the world’s second-largest crude consumer by making dollar-denominated imports more expensive.
The net-long position in WTI slipped by 12,472 contracts to 99,748 futures and options. Shorts increased 9.7 per cent, the seventh gain in eight weeks, while longs advanced 0.8 per cent.
In other markets for the week, net bullish bets on Nymex petrol dropped 7.4 per cent to 13,553. Futures rose 0.5 per cent to $1.6937 a gallon. Net bearish wagers on US ultra low sulphur diesel increased 12 per cent to 30,548 contracts, the most since April. Diesel futures rose 1 per cent to $1.5629 a gallon.
Bullish bets on crude have tumbled by more than half since May to near a five-year low, CFTC data show. Short positions are nearing the highs from March.
“We could see them jump back in on the long side soon,” said Michael Lynch, president of Strategic Energy & Economic Research in Winchester, Massachusetts. “There’s always an effort to guess the bottom of any move.”
* Bloomberg
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