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Why Did Oil Decline on Monday?

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Oil Declines

Why Did Oil Decline on Monday?

July 7 2015, 06.53am GMT


Monday saw oil futures record the sharpest drop in price since April, on the back of increasing political and economic uncertainties, many of which can affect both the supply and demand chain.

The price for August crude (CLQ5, -0.74%) on the NYMEX found a new level at $52.53 per barrel, a decline of 7.7% or $4.40. Meanwhile, August Brent crude (LCOQ5, +0.92%) settled at $56.54 on the ICE Futures Exchange in London, showing a loss of $3.78 or 6.3%.

In purely economic terms, the failure of the Chinese economy to gain any impetus with the latest PMI numbers showing a further decline, point to a drop in oil imports by the world's second largest oil importer. Capital Economics commodities economist Thomas Pugh highlighted the fact that Chinese oil imports fell by 10% year to date. Coupled with the recorded fall-off in demand, Tim Evans, chief market strategist at Long Leaf trading Group said that the decline of the Hang Seng Composite Index (HSCI, -1.97%) of 3.8% “also suggests a weaker demand for oil moving forward”.

The continuing uncertainty of the financial crisis in Greece where the emphatic “No” vote has resulted in more questions rather than providing answers, is also playing its part in the oil price uncertainty. The mixed signals coming from Greece, where 61% of the voters showed a refusal to accept the austerity demands of the eurozone, could lead to Greece abandoning the euro with all its implications. Compounding the confusion is the result of a poll conducted in Greece by GPO for Mega Television which shows that 75.6% of the Greek population wants to stay in Europe. This is very much a scenario where the Greeks are saying we want to eat our cake while at the same time we want to keep the cake, which are directly opposing desires.

The danger to oil consumption does not come from Greece itself, which is a big player as an oil importer, but rather from the contagion that might set in affecting markets in the rest of Europe and beyond.

With President Obama seemingly set on achieving a deal with Iran on the nuclear front, Iran could well come back into the picture as a major oil producer and exporter if sanctions are lifted as a result of the proposed deal. There is no doubt that Iran will try to ramp up production and exports in order to recover economic ground lost as a result of the sanctions.

Also, last week, the U.S. Energy Information Administration figures reported the first weekly increase in crude oil supplies since April while at the same time, the Baker Hughes (BHI, -1.74%) weekly data indicated that the number of rigs drilling for oil increased for the first time this year. Capital Economics Pugh concludes that U.S. oil production is set to pick up going forward.

Meanwhile, a Platts survey of OPEC showed that oil production in the Organization of Petroleum Exporting Countries climbed to its highest level since August 2012. Tim Evans, energy analyst at Citi Futures stated, “We remain concerned that OPEC production continued to rise in June”.

The equilibrium in the oil price is constantly affected by the laws of supply and demand. The potential for falling oil consumption in China and the risk of contagion from the Greek crisis tip the scales in favor of a decreasing demand for oil, on its own enough to cause a fall in prices.

Added to this, the ever increasing supply by OPEC members, together with the possibility of Iranian production coming back on stream and increased U.S production, in turn tip the scales in favor of increased oil supplies on the market. This again is sufficient on its own to result in declining prices.

Taking the influence that all these negatives can have on oil prices into account, Capital Economics released a note on Monday lowering its end of 2015 forecasts for Brent crude to $55 a barrel from a previous forecast of $60. Its forecast for WTI crude for the end 2015 is also down by $5 from the $55 forecast earlier to $50 per barrel.

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