Oil to Remain Under Pressure into Next Year
As major stock benchmarks around the world continue to push forward to long-term highs, less focus is being placed on commodities markets (which have not participated in the optimism). If there has been any significant attention being paid to these areas, it has been focused on gold. But this is mostly because the precious metal is now on pace to post its first yearly decline in more than a decade. With all of these distractions in place, much less attention has been paid to the underlying oil price and the assets most highly correlated with its volatility. The United States Oil Fund LP ETF (NYSEARCA:USO) has fallen nearly 16.5% since the beginning of September and more than 27% from the highs seen in May 2011.
But while extreme moves like these might seem attractive for investors looking for contrarian value, there is reason to believe that any corrective rallies we see into next year will be limited in scope. The diminishing outlook for energy demand and the increasing prospects for supply levels paint a bearish picture for oil markets and should cap any real attempt for bulls to push valuations higher. Perhaps the most detrimental effects will be seen on the supply side, as the shale oil revolution in the US and rising productivity levels in Iraq generate excess that outpaces demand even under the most ideal growth scenarios. Growth rates in US shale oil productivity will be the bigger factor of the two but the important point to remember here is that the collective scenario simply does not lend itself to major rallies in oil, even if we see surprising results in global growth.
Those that disagree with this outlook and are bullish on oil might point to the possibility that the US Federal Reserve will continue pumping monetary stimulus into the economy, and that this will keep consumption levels robust on a relative basis. But these arguments miss the positive surprises in employment data and broad GDP growth that have been posted thus far. The Fed is now in a position where some reduction in stimulus has become necessary. Once we see confirmed views in this area from voting members of the central bank, market repositioning will bring additional weight to any potential rallies in the underlying oil price as demand levels (particularly in emerging markets) stall in response.
US Dollar Impact
Add to this the negative impact that would come as a result of the Dollar strength that would be seen in these scenarios. The inversely-correlated relationship between the US Dollar and commodities in the precious metals space has already become apparent this year -- but has yet to make its presence felt to the same degree in energy markets. The PowerShares DB US Dollar Index Bullish ETF (NYSEARCA:UUP) has shown weakness in the recent trading sessions, but the rebound from the October lows has become readily apparent and the macro picture supports further gains. The chart perspective shows changing sentiment as resistance in the 21.70 region has been removed, and the upside potential seen at this stage far outweighs downside risk. As the supply side outlook remains sufficient, next year's averages in West Texas Intermediate (WTI) will likely hold below the $98 mark, with Brent prices fluctuating in ranges around $7 higher; not exactly the picture energy bulls would like to see.