Super-sized supply sees GFC price levels

2015 is barely three trading days old and already the two biggest themes that were predicted to affect the markets this year are making headlines – oversupply of commodities and the Eurozone.

oil
Source: Bloomberg

Currently, major oil producing nations are behaving like McDonalds, asking would you like to ‘super-size’ your supply?

I completely understand the logic behind the oversupply; major oil-exporting nations such as Russia, Iraq, Saudi Arabia and Kuwait are all jostling for a share of a stagnating oil market to offset the plummeting oil price.

Russia’s output is now at its highest level since Soviet Union days. Iraq has just announced it is will increase supply to its highest levels on record. The 12-nation OPEC bloc has been pumping above its production targets for the seven months to December 31. The oversupply from the bloc will send some of the smaller nations to the edge.

The two G10 currency countries most affected by the move in the oil price are Canada and Norway, as they are major producers themselves. Since West Texas Intermediate (WTI) hit US$101 a barrel in late June last year, USD/CAD has moved from $1.07 to $1.18 – a 10% decline as of last night. NOK/USD has fallen 20% in the same period.

However, this is just part of the story. Since the June high in oil, EUR/USD has fallen 12.7%. As the Eurozone is a meaningful net importer of oil, the falling EUR will mask the fall in the oil price, meaning demand from the 19-nation zone will remain flat and see the supply glut remain.

The fundamentals in oil are unlikely to change in the first half of this year, which will see oil bedding down into its bear market for months to come. The US is unlikely to reduce its production levels as the shale gas revolution continues to pick up pace and US output remains at its highest level in three decades. All this saw WTI falling below US$50 a barrel in New York – its lowest since mid-09. Brent Crude was below US$55 a barrel in London – also its lowest level since mid-09.

So ‘super-sized’ supply is here to stay in the interim. However, there could be one major positive from an economic prospective if supply remains the same – economic stimulus. Cheaper energy means reduced costs and expenditure for commercial enterprises and consumers, which in theory should spur growth. On the other hand, if net importers such as the Eurozone continue to see energy prices hold due to the slide in the currency, this effect will be minimal.

Further fault lines in the Eurozone    

The Eurozone is also starting 2015 on further talk of faltering. There is a growing market rumour that Germany would accept a Greek exit from the common currency. Major German magazine Der Spiegel is citing sources close to Chancellor Merkel, saying she would accept such an exit – I would suggest this should be taken with caution. I think it’s a very unlikely scenario. However, that will not stop the media hype and the subsequent market reaction because of it.

The contagion fears of 2011 and 2012 are easily repeated on news like this. However, unlike then, the Eurozone is in a much better position. Despite this, the bloc still finds itself in the grip of disinflation and possible deflation in the periphery; it wouldn’t require too much of a push to see this flare up again.

That begs the question of whether the ECB will (as reported) embark on a large-scale sovereign bond buying program. All reports lead to this, but I would ask myself these questions: Will the Germans want the ECB buying Greek or Portuguese sovereign debt? And would this lead to massive inflation in Germany, as German bunds would have to be the largest purchase by the ECB as it is the largest nation in the zone?

Hyper-inflation is something the Germans fear more than anything. Monetary governance of the zone is going to be a tricky this year.

Ahead of the Australian open

Based on the moves on the European and US markets, we are calling the ASX down 91 points to 5359. The energy stocks found support yesterday despite the slide in oil over the weekend. I don’t see how they will manage to buck the trend for a second day and are likely to catch up with the falls that were expected yesterday. BHP’s ADR is pointing down 4.2% to $28.23 as iron ore and oil bear markets lead investors to conclude FY15 will be a tough year for the world’s largest miner.

Low volumes are also likely to affect trade. Historically, January is the lowest-volume month of the year, with the first two weeks of January normally very low indeed. Expect erratic trading and overreactions on the lower levels of trade.

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