In Pinnacle Advisory Group’s previous ETF Strategist article, Rick Vollaro highlighted the synchronous moves between the oil markets and other risk assets including the S&P 500 (SPY) and High Yield (JNK).
He wrote that it would be wise to watch oil markets since one’s oil outlook would be equivalent to an outlook on the other aforementioned asset classes. For us, this is one of the reasons for a slightly cautious stance on risk assets as we feel the recent move higher in oil prices is not justified based on current fundamentals.
The oil supply picture is getting worse by the day as inventories continue to rise. The high inventory will continue to weigh on crude oil stocks as U.S. storage capacity is reaching its limit. Additionally, while U.S. production has been slowing, it has not been enough to offset imports from the Middle East.
On the demand side, the IEA released the following outlook on March 11, 2016: “Sharp decelerations in demand growth—particularly in the U.S. and China—pulled global growth down to a one-year low of 1.2 mb/d in 4Q15, compared to the year earlier, dramatically below the near five-year high of 2.3 mb/d in 3Q15. A gain of around 1.2 mb/d is forecast for 2016.”
As the global growth slowdown continues to play out, weaker demand is expected. Absent a quick revival in global growth, it is hard to see the demand picture brightening in the short term.
Furthermore, refineries are unlikely to demand more crude oil in the near future as they perform seasonal maintenance ahead of the driving season and look to work off massive distillate inventories built during the warm winter.
This leaves us with a very unbalanced oil market as it relates to supply/demand. As we reach the tipping point in terms of oil storage, something has to give. Our most optimistic view is that a combination of supply/inventory reductions and a drop in oil prices will ultimately balance the market by year end. But how far prices have to fall when oil producers rush to sell their product remains to be seen.