There is a glaring weak spot in the capital markets this morning and that spot is oil. Crude futures for West Texas Intermediate are down 2.3%, or $1.16, to $49.12 per barrel. This morning's move comes on the heels of a 5.4% decline on Wednesday, which followed bearish inventory reports from both the American Petroleum Institute and the Energy Information Administration (EIA).
Trading sentiment has soured in a hurry, primarily because there was so much crowded positioning in a trade that favored oil prices moving higher.
That positioning was precipitated by the noteworthy production cut agreement between OPEC and certain non-OPEC countries, and subsequent reports highlighting significant compliance with that agreement. Those reports helped sustain oil prices in recent weeks despite weekly inventory reports pointing to a continued build in U.S. stockpiles.
Things came to a trading head yesterday, however, when the EIA inventory report revealed an 8.2 million barrel increase in oil inventories and a 6.6 million barrel drawdown in gasoline inventories.
A draw in gasoline inventories has often placated oil traders, as it points to a future likelihood of increased oil demand for refining purposes. On Wednesday, though, there was no such support as the recurring build in oil inventories, and the confluence of other factors, proved too much to bear for the speculative crowd holding long positions.
The end result is that traders gave up on the trade, and knowing that it was a very crowded trade, selling efforts escalated in a hurry on a proverbial rush to the exit. That escalation stemmed in large part from the fact that there wasn't really any support to be offered from short sellers looking to take profits since the crowd was predominately a long crowd.
Other contributing factors coming together to put a major dent in trading psychology have included the following:
- The persistent strength in the dollar, which is a headwind for the dollar-denominated commodity
- Recent remarks from the Saudi oil minister that cast doubt on Saudi Arabia's willingness (and OPEC's for that matter) to keep supporting prices with production cuts
- The recognition that shale producers have ramped up production to take advantage of the higher price deck that was established on the back of the production cut agreement between OPEC and certain non-OPEC countries
- The move below $50.00, which was seen as a technical level of support; and
- A momentum trade that is now cutting the other way as long speculators abandon their positions
Naturally, the retrenchment in oil prices is regarded as a negative for the energy sector, which paced Wednesday's retreat in the broader market and which has actually underperformed since the start of the year.
That underperformance seems likely to continue today given the price action in the energy pit and the rapid deterioration in trading sentiment. The United States Oil Fund (USO 10.67) and the Energy Select Sector SPDR ETF (XLE 69.65) will be among the funds vulnerable to a continued sell-off in oil prices.