The Overnight Report: Oil Shock

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By Greg Peel

The Dow closed up 40 points or 0.2% while the S&P gained one point to 2039 and the Nasdaq rose 0.1%.

The ASX200 meandered lower yesterday as investors shifted into a more defensive stance. The energy sector posted the biggest fall with some contribution from the banks, while healthcare, utilities and the telco held firm. The price of oil continues to be the talking point of the moment and that will again be the case in today’s session.

China’s monthly data-dump did little to buoy the mood. Chinese industrial production grew by 7.7% year on year in October, down from 8.0% in September and falling short of 8.0% forecasts. Fixed asset investment fell to 15.9%, its lowest level since January, while retail sales growth ticked down to 11.5% from 11.6%.

The lower oil price was mostly blamed for a 0.3% fall in Germany’s October CPI, down from 0.0% in September.

Just what is OPEC, and the Saudis in particular, going to do about the price of oil? No one is at all sure. Last night the Saudi oil minister spoke of wanting to have a stable oil market and not wanting to engage in any price war, but what does that mean? OPEC is not keen, it would appear, to cut production in the face of tumbling prices, as it has always done in the past. Last night it was revealed per-day US oil production has reached its highest level in 28 years, so one can hardly blame the Saudis for believing production cut responsibility, this time, lies elsewhere.

Last night West Texas crude fell US$2.52 to a four-year low of US$74.34/bbl. Brent fell US$2.04 to US$77.92/bbl. It is beginning to look like a capitulation trade, given last night’s weekly US inventory numbers were lower than expected, which would normally push prices up. Deutsche Bank has suggested that at US$60/bbl, marginal US shale oil production will be forced to start shutting down. The Saudis are potentially prepared to weather the pain of such a price if it does have the effect of taking the heat out of US production growth, therefore ultimately leading to some price stability.

On the other side of the equation, US commentators are very excited about the prospect of structurally lower oil prices boosting the spending power of the US consumer. It’s not simply a case of relief at the pump, but of a comprehensive flow-through to lower transport and production costs and thus a lower price for goods. With Christmas approaching, economic bulls are licking their lips.

Wall Street is uncertain. It’s hard to shake off a longstanding assumption that oil prices are a global economic bellwether, and lower oil prices mean a slowing economy. Yet while data out of China and the eurozone confirm slow growth, falling oil prices have little to do with falling demand and a lot to do with rapidly rising supply. This is not the sort of “supply shock” America is used to.

The US stock indices also meandered last night before posting a mildly positive close. While the relative market cap of the US energy sector is diminishing each day, it is still acting as a drag on index performance.

The story is somewhat different in metal markets, where demand is a more of an issue than supply. While LME traders largely took last night’s Chinese and European data on the chin, base metal prices were uniformly weak across the board, falling 1.0-1.5%. The stronger US dollar is another headwind for dollar-denominated commodity prices, but last night the US dollar index drifted 0.1% to 87.17.

There was nevertheless some mild relief for nervous iron ore producers last night. Iron ore rose US10c to US$75.50/t.

Gold was steady at US$1157.70/oz. The Aussie was also steady, at US$0.8717, while the US bond market appears to have decided 2.35% is about the right level for the ten-year yield for now.

The SPI Overnight closed up 4 points.

The world is looking ahead to the annual OPEC meeting in two weeks’ time. But tonight brings the first estimate of eurozone September quarter GDP, while US retail sales, inventories and consumer sentiment will be in focus.

There is a handful of local companies holding AGMs today, including Lend Lease ((LLC)) and News Corp ((NWS)).
 

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