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  1. Home
  2. / Investing
  3. / Stocks

The Oil Market Is Cheap, So Why Does It Keep Falling?

Cheap can always get cheaper in the commodity space, and this will be true for the oil markets until demand picks up.
By MALEEHA BENGALI
Sep 03, 2020 | 10:05 AM EDT

The market has been fed with enough liquidity over the past few months to distort the true underlying trend of the economy, trapping money in a handful of stocks and sectors. When newbie traders and advisors advise clients to "buy" a stock for a catalyst such as a stock split, one should not only revoke their license, but they should be banned from trading altogether.

Buying a stock for momentum is one type of logic, but when you justify buying it because of a technical event that really serves no benefit fundamentally or technically, you are blatantly lying. Moreover, if you claim to have made money, it would be pure luck and timing, nothing more. To claim otherwise is simply foolish.

But just like in 2000, if you cash in and cash out in a timely manner, kudos to you. End of the day, it is all about monetizing, no matter how illogical the rationale may be. Forgetting the shenanigans in technology stocks, which have become a legal form of gambling for tired and bored work from home investors, the oil market, thankfully, is still maintaining some sort of rational fundamental behaviour. Perhaps because it is too big to be pushed and pulled by average teenage retail traders as it has a big physical market that dwarfs any financial flow.

Brent oil has been holding around $40-$46/bbl for the past few months, whereas WTI has been ranging between $37-$43/bbl recently. Given the move higher in copper, gold and silver -- all inflation plays -- most are wondering why the oil price is still lagging and positioned for the catch-up trade. The macro only helps the oil market if the physical markets support its theory.

To put it simply, there is just too much oil production, despite OPEC+ supply of 7.7 mbpd of oil sitting on the sidelines. Demand had bounced from its artificially low March and April levels, but it has been plateauing over the past few months, unable to really pick up and soak up all that extra supply. That is in essence the problem, demand is less than supply.

The Fed can pump all the money it wants to boost asset prices and try and stoke inflation by keeping rates low, all this does is feed money into technology and growth sectors. As they benefit from a higher discounted cash flow, this means nothing for stocks that have no earnings growth to begin with, namely the oil majors and large-cap exploration and production companies.

The Fed cannot force people to fly or to travel, or industries to spend more on growth and hiring. It can only support asset prices so that they do not fall into oblivion. The economic growth has to come from the underlying economy -- and that we are not seeing. Citigroup's latest economic surprise index has fallen recently, showing how the initial bounce post lockdown is now slowing down. The economy is faltering and job growth is non-existent. This has and will continue to put a dent in the consumer's pockets, which will affect overall demand for select commodities.

On the supply side, OPEC+ has been getting anxious over the past few months and members desire to produce more to monetize their overall production levels. Now that oil prices have been stable, they seem to feel that the need to cut is not as severe as it was back in April. Also, given the budgets of countries like Kuwait, Saudi Arabia, etc., they would rather produce more than less here to meet their spending needs. Any friction in the current pact will not bode well for the oil price. Not to mention, Russia is now making noise about how it sees demand recovering to 90% of the pre-pandemic level and is also getting itchy to produce more.

U.S. production has fallen from its highs in March, but they are still producing around 10.5-11 mbpd. We may not see 13 mbpd for some time -- or ever -- but the world still has a lot of oil. If demand does not pick up, or until people feel safe to travel and restrictions are eased, this will not remove the overhang in the oil markets.

People who analyze the commodity markets from an equity market lens will always get frustrated, as value in the commodity market is meaningless. Cheap can always get cheaper, especially if physical markets show an excess balance of that commodity versus its overall use. Unfortunately, that is the sad reality for the oil market.

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At the time of publication, Bengali had no positions in any of the securities mentioned.

TAGS: Fundamental Analysis | Investing | Markets | Oil | Stocks | Energy |

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