The Overnight Report: All About The Oil

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By Greg Peel

The Dow closed down 162 points or 0.9% while the S&P lost 0.7% to 2063 and the Nasdaq fell 0.1%.

Capitulation?

In depth analysis is not required to figure out why the ASX200 closed down 0.9% yesterday. Energy was down 6.4% and materials 3.4%, as both benchmark prices for oil and iron ore are now under the psychological US$40 mark. All other sectors traded off gains and losses of around a half a percent.

The big fall in the energy sector was compounded by Woodside Petroleum’s ((WPL)) announced withdrawal of its bid for Oil Search ((OSH)), thus removing a takeover premium from the Oil Search price. To explain the big fall in BHP Billiton ((BHP)), again, one must remember that while BHP is mostly thought of as an iron ore producer, it also has a large energy division.

The unfortunate reality for the market in general is that while recent falls can be squarely blamed on the resources sectors, as opposed to market-wide concerns, a lot of technical damage is being inflicted on the index. The 5100 level is considered support which, if breached, suggests another move down towards 4900. However, if investors can take anything away from the performance of Australian stocks in 2015, it is that index-tracking has been a disastrous strategy this year. Stock-picking has ruled, particularly outside of the large caps, with only one or two exceptions (CSL comes to mind).

It was probably never going to make much difference what China’s November trade numbers, released yesterday, looked like. It was not a day to be brave when playing the resources. Weak numbers would have been met with a “Yeah, well there you go,” and strong numbers would have been trampled in the stampede anyway.

As it was, the numbers offered a balance of sorts. They were weak, but not as weak as expected. Exports fell 3.7% year on year in November compared to 3.6% in October, but that was not as bad as expected, and imports fell only 5.6% following a 16.0% fall in October. Forecasts had suggested another double digit fall.

It is interesting to note the impact of China’s August currency devaluation. In USD terms, exports fell 6.8%, better than 6.9% a month ago, and imports fell 8.7%, better than the previous 18.8%. The numbers look worse in dollars, but is there a trend of stability emerging?

That’s a big question for 2016. Meanwhile, more immediately, have we seen the bottom for oil and iron ore prices? Monday night’s 6% trashing of oil had a hint of capitulation trade about it. Iron ore’s decline has been rather more orderly, so it is difficult to tell when that might stop. Iron ore is also beholden to Beijing’s efforts to reduce excess steel capacity – a slow process – while Beijing has no control over oil markets. That’s all down to US shale producers and OPEC.

Overnight WTI initially fell again, but found some support under the US$37/bbl level before closing only slightly lower on the session. It would be a brave trader who would suggest we’ve definitely now seen a bottom, and bottom-pickers who moved in too soon mid-year have been taken out on stretchers. But with all the talk of which US oil companies are now set to go to the wall, implying reduced supply, it may be time to look at those companies that can survive and maintain dividends. If you are stout of heart, that is. At least, that’s the call from some stout-of-heart US fund managers right now.

Wider Implications

WTI crude fell initially in last night’s session by about another dollar before finding support and rallying to be up slightly. It is currently down slightly on the session. The Dow fell 245 points in the morning before rallying back to be down 160 points. It was all about oil.

Traders were clearly hiding in the big tech space while the oil story played out. Hence we see the Nasdaq flat on the session. The S&P split the difference.

It might be all about oil, but wider implications threaten the US financial sector. Billions had been lent to mostly smaller shale oil companies by mostly smaller regional banks in the US at pervading low interest rates, against hedged barrels. Those hedges have now rolled off, the Fed is about to begin a tightening cycle, and many a shale producer was already burning cash under US$60/bbl, let alone under 40.

Wall Street is thus nervous about the flow-on effect into the financial sector. This is not the case in Australia. Outside of BHP, Australia’s Big Oil names are heavily exposed to LNG rather than crude, and the big LNG projects are financed mostly through pre-organised offtake agreements and, as is the case recently for Santos for example, fresh equity. Australia’s banks are negligible lenders to the energy sector.

Until oil can find a bottom, or at least some stability, the spectre of energy sector defaults and bankruptcies will worry Wall Street. The irony is, of course, that the more oil companies go bankrupt, or at least throw in the towel, the more likely the oil price is to stabilise on reduced production.

Commodities

West Texas is down US5c to US$37.57/bbl and Brent is down US45c to US$40.21/bbl.

In Australia, the focus is as much on iron ore as it is on oil, whereas in the US, oil is the far more dominant stock market sector of the two. Iron ore has not seen 6% overnight plunges and is not prone to such volatility, being more of a China-dominated rather than global market place and trading nothing even remotely close to the volumes that go through the oil market each day.

There is no doubt concern, nevertheless, that as the iron ore price continues to quietly slide – it’s down another US10c to US$38.80/t – there appears no reason for a bottom-picking cavalry to suddenly appear for a short-covering scramble to hint at possible consolidation. Thus junior Australian iron ore miners who are burning cash are facing heightened financial risk. But again, Australia’s banks are not in the business of lending vast sums to junior miners.

On the LME, activity has almost ground to a halt. Traders suggest end-of-year blues and next week’s Fed meeting are keeping the punters away at the moment. Last night saw mixed and smallish moves among the base metals, with the highlights being one percent falls for nickel and tin and a one percent rally for lead.

The commodity price issue has taken further toll on the Aussie dollar, which is down another 0.8% at US$0.7208. The US dollar index is also down, by 0.2% to 98.44, and gold is relatively steady at US$1073.80/oz.

Today

The SPI Overnight closed down 23 points or 0.5%. A breach of 5100 threatens for the ASX200.

Yesterday’s NAB business confidence survey was fairly benign, but today we’ll see Westpac’s consumer equivalent which has particular importance at this time of the year. We’ll also see housing finance data, which is also a strong focus of attention at present.

Beijing will release Chinese inflation data today.

 

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