Commodities | Oct 31 2013
We continue to be bearish oil in 2014, however we are fully aware the market takes time to find its terminal point given a particular set of ideas. Last week we mentioned that the market would remain bearish unless we have some geopolitical concerns from the Middle East, and it looks like the situation in Libya once again is turning for the worst and as result we are starting to see a premium built into the Brent price. The actions to date have put a low in play and suspect that we are amidst a short covering rally.
Libya used to produce close to 3.5 million barrels per day (bpd) or roughly speaking 4% of global production. Since the demise of Colonel Gaddaffi, the transitional governments have been finding it difficult to cement a true democracy. Discontent amongst various factions in the Government has seen the unrest erupt into violence and the possibility of a re-emerging civil war is been looked at seriously. The country still has no constitution and with the power vacuum that has emerged, the economy is stagnating. Oil production did manage to get to upwards of 1 million barrels over the last 2 months which was an encouraging sign for the country's finances, however since last week it dropped to only 100,000 bpd and with violence spreading it will not take long before the oil-rich nation's income from the commodity will be zero. This only exacerbates the tension as the country earns 85% of its income from oil sales, which represents 80% of its GDP and 99% of the income for the government. As the country plunges towards chaos the loss of production will have an effect on prices.
It is interesting that to some extent we had mistakenly discounted the effects of the violence in the region, as we understood that receiving income from sales is an overriding influence. Countries need income, however the fact that production has dropped dramatically has sent a shudder down the proverbial pipeline. It looks like WTI is being supported by the Brent contract and since 85% of Libyan oil heads to Europe, the Brent contract seems to be the main beneficiary of any move. It is interesting that the move in the commodity is purely Libyan based as the spread between WTI and Brent has widened the most since Sept 18. We suggest that this conflict, like Syria, could continue to escalate due to power mongering and as a result it will help underpin any moves higher on the commodity.
As it stands we are long Brent and short WTI, expecting the spread to widen further.
Chart Point – WTI Oil:
We continue to see further downside for WTI however it just may be dragged up by Brent so adopt a little caution if going short WTI.
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