Recent Oil Price Volatility More Psychological Than Fundamental

May 2017

Rising fears and impatience recently triggered a sell-off in energy, despite lack of changes in fundamental data.


Recently volatile oil prices seem to suggest investors have grown increasingly concerned about a market recalibration. As $50 remains a key psychological level for investors, the breach downward below $47 (considered a significant technical support level) triggered a panic-like sell-off despite a lack of changes in any significant fundamental data that would support the decline.

With no fundamental catalyst for the move down, the energy team at Jennison Associates can only surmise the decline was likely triggered from the rising impatience from investors on the slow pace of falling crude inventory levels, coupled with recently released data showing a higher-than-expected rebound in US production. This likely led to a capitulation (“throwing in the towel”) among macro-fund managers selling energy, quant-based managers shorting energy and buying other market sectors, and hedge fund managers who over the past several weeks appear to have been liquidating energy positions and de-risking. However, given that no hard data has materialized to support this view, Jennison Associates maintains that oil fundamentals remain strong and continues to believe that markets can reach $60/barrel by the end of the year.

WTI crude oil prices
WTI Crude oil Prices
Source: Bloomberg as of 5/5/17.

Strong global demand even if China slows
Declining copper and iron ore prices recently cast doubt on Chinese demand growth. By extension, investors questioned Chinese oil demand and subsequently oil prices slid below $50. Yet, it’s important to note that China is a more prominent consumer of metals than of oil and even so, there is no hard data pointing to a significant slowdown in China's economy. However, even if growth slows in China, it should have a muted impact on oil prices as China represents a small fraction of global demand, which remains strong. Also, remember that similar fears about a Chinese slowdown and reduced demand arose in late 2015 through early 2016 and largely contributed to the plunge in oil prices, although those fears later proved unwarranted as demand increased from 2014 to 2016.

US supply to become more selective
US shale drillers can continue to grow with oil prices below $50 and the growth will be healthier as they focus production on more profitable US basins (such as the Permian and SCOOP/STACK). An important detail that may be overlooked is that the increase in rig counts is coming from the more profitable basins, with less rig count expansion elsewhere. Other basins are seeing slowing growth, which should soon play out in inventory levels, given demand trends.

Key takeaway
With no major shift in supply/demand fundamentals, it’s likely that the energy markets will continue to rebalance. However, market jitters may weigh on oil prices in the near term as investors await data confirming inventory drawdowns and the decision from OPEC and other heavyweight producers on whether they will extend production cuts past July.

The Organization of Petroleum Exporting Countries (OPEC) is a union of oil-producing countries that regulates the amount of oil each country produces. SCOOP/STACK is an acronym used for specific basin locations: SCOOP (Southern Central Oklahoma Oil Province) and STACK (Sooner Trend, Anadarko Basin, Canadian & Kingfisher counties). West Texas Intermediate (WTI), also known as Texas light sweet, is a grade of crude oil used as a benchmark for oil pricing.

The comments, opinions, and estimates contained herein are based on or derived from publicly available information from sources that Jennison Associates believes to be reliable. We do not guarantee the accuracy of such sources or information. Investing involves risks. Some investments have more risk than others. The investment return and principal value will fluctuate and the investment, when sold, may be worth more or less than the original cost and it is possible to lose money. Past performance is not a guarantee of future results.

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0305369-00001-00 Ed. 05/2017