Over the course of several days, crude oil prices proceeded to fall almost $10 per barrel, as the markets continued to weigh the consequences of a spreading European sovereign crisis. Given that Greece is a relatively smaller economy, I am not overly concerned about a potential default. I tend to view the Greek drama situation as a wake- up call for the UK, US, and other major economies with considerable budget deficits. On April 27th, Spain, Portugal, and Greek were furthered downgraded by one of the major rating agencies and placed on Negative Outlook triggering the fall in both equity and commodity prices. So what does that mean for crude prices?
It means that expectations of a global economic recovery may be postponed as markets now encounter and digest yet another crisis. If a global economic recovery stalls, looming sovereign downgrades have the potential to put downward pressure on crude oil prices. It is also important to note that Spain, Portugal, and Greece were all placed on Negative Outlook. This signifies that further downgrades may be imminent, within the next year, if these countries don’t take considerable measures to improve their economies to the satisfaction of the rating agencies. This is a shot across the bow to get your respective economic house in order sooner rather than later.
At worst, sovereign defaults have the potential to drag down commodity markets along with them. Think Russian default or Asian economic crisis of the 1990’s. Prior to this correction, crude oil prices were getting ahead of themselves at $86 per barrel. At $75 per barrel, crude oil prices are still healthy and permit the industry to continue investing. Furthermore, the Contango spread has increased as Cushing and Oklahoma crude oil inventories increase. The result of this now has Brent crude trading at a premium (over $4 per barrel) to WTI. Storage becomes a strategic advantage in these situations where potential arbitrage opportunities may be present. Inventories levels on the US side of the Atlantic are currently 10 million barrels above the five-year average of 349.9 mm barrels.
Given that there is ample inventory of crude and refined products, a market correction was expected. Over the near term, I anticipate continued market volatility until the European sovereign issues stabilize and a resolution implemented. What is becoming readily apparent is the risk and fear of a sovereign debt contagion is far worse than…
