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What’s behind the crash in crude?

What’s behind the crash in crude?
Oil prices crashed to new one-year lows on Tuesday, dragged down by a deepening sense of global economic gloom as well as fears of oversupply in the oil market itself.

The reasons for the sudden meltdown were multiple. Rising crude oil inventories and expected increases in shale production weighed on oil prices, but the price crash was accentuated by the broader selloff in financials.

Genscape said that inventories are rising, which has raised fears of tepid demand amid soaring supply growth. “The Cushing number came in higher than anticipated ... it's definitely pointing to the concern that there's more supply and demand is weakening,” said Phil Flynn, analyst at Price Futures Group in Chicago, according to Reuters. “The market is still very nervous about that.”

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Crude prices fell four percent on Monday and by a similar magnitude on Tuesday. WTI dropped below $48 per barrel and Brent was down below $58.

The EIA said in its latest Drilling Productivity Report that it expects US shale production to top 8.1 million barrels per day (mb/d) in January, rising by a massive 134,000 bpd month-on-month. The Permian alone will see production rise by 73,000 bpd next month. By way of context, the gains in the Permian are bigger than even some of the large monthly declines that we have seen in Venezuela, for instance.

Still, with WTI dropping below $50 per barrel, shale drillers will start to face increasing financial strain. That could force a slowdown in the shale patch. “We’re probably going to see a supply slowdown in the US,” Michael Loewen, a commodities strategist at Scotiabank, told Bloomberg. “I do think that producers will react.”

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But the malaise sweeping over the oil market can also be chalked up to broader fears of a global economic slowdown. US equities crashed on Monday and stocks in Asia were also sharply down on Tuesday. The Dow Jones Industrial Average is down 12 percent since early October, and in fact, the S&P 500 is down nearly five percent on the year.

The Federal Reserve is expected to announce another rate hike this week. Rising interest rates have been blamed for increasing borrowing costs, strengthening the US dollar, injecting volatility into emerging markets and setting off capital flight in some countries.

READ MORE: As US debt spirals to $22 trillion, former Fed chair Janet Yellen is suddenly concerned

More importantly than this week’s rate hike will be direction from the Fed on what it plans to do next year. Originally, the central bank had hoped to keep rate hikes on track, but financial volatility could force it ease up. A softer tone could provide some relief for financial markets.

It’s unclear if the angry pressure from President Trump on the Fed will have any effect, but Trump’s anxiety about interest rates is not entirely misplaced. With inflation low in the US, and heightened volatility and weak growth seen elsewhere, many economists question the wisdom of continuing to hike interest rates. “If monetary policy doesn’t change its direction, you will have a significant meltdown on this,” Steven Ricchiuto, chief US economist with Mizuho Securities, told the New York Times. “So there’s a lot riding on it.”

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But the problems could be deeper. The US housing market is showing signs of strain (higher interest rates have certainly not helped). Auto sales in Asia are down. Germany saw its GDP contract in the third quarter. The US-China trade war has already inflicted damage on the economy and could still grow worse. Unless there is a rebound in stocks over the next two weeks, 2018 could be the worst year for US equities since 2008, which is all the more remarkable given the steep rally that unfolded over the first half of the year.

A general economic slowdown would likely cut into oil demand figures for 2019. It’s an ill-timed development for OPEC+, which just announced production cuts in order to try to balance the market. An economic downturn would make OPEC+’s job much more difficult. “The stabilisation on the oil market is already history…and the effect of the announced production cuts after OPEC’s meeting has evaporated entirely,” Commerzbank said in a note.

This article was originally published on Oilprice.com

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