Daily Energy Report
Energy Price Outlook
Oil prices may stabilize and begin to move higher over the next few days. The strong selling that took place on Monday and Wednesday affected energy markets more than any other commodity and the cause is still unknown. Selling by an algorithmic trading system is still a strong possibility as open interest has fallen 47K contracts between Monday & Wednesday. An end to the system’s liquidations could create enough stability that encourages bargain-hunters to re-enter the market on the long side. Support could also come from ongoing Middle East tensions and from the likelihood that Wednesday’s inventory figures reverse to a degree next week.
Energy markets finished higher yesterday after beginning the session to the downside. Early pressure was offered from follow-through selling after weakness earlier this week, as well as from disappointing PMI data in China and the Eurozone. The HSBC PMI was reported in China and could be key for oil prices in the near-term as it has been below the 50.0 expansion/contraction point for 11 straight months. It has loosely correlated to Chinese oil demand in recent years, as shown in the first chart below (in PDF document). The level of Chinese oil demand has fallen from December’s 10.02 mb/d to 9.25 mb/d as of August. The EIA’s estimate of Chinese demand this year is shown in chart 2 and actually shows a much different picture from the Bloomberg data. Since the December peak in Bloomberg data, the EIA has projected an increase in demand of nearly 500 kb/d to 10.22 mb/d. The EIA’s projected demand figures are higher too, and may have to be downgraded as a result. The weakness in the PMI data was rightly negative for oil prices at the opening of trade yesterday.
The market rebounded though, as the “flash crash” that took place on Monday and followed through on Wednesday didn’t see further follow-through yesterday. An analysis by Reuters yesterday made an analogy that the original flash crash on May 6th 2010 was caused by an program that intended to sell 75,000 E-mini S&P contracts. The sale was done via an algorithm which targeted selling quantities of 9% of trading volume in the previous one-minute, and paid no attention to price or time. The sales were initially absorbed by High Frequency Traders which then pushed volumes higher. That fooled the algorithm into thinking that there was more liquidity than was actually the case, which then caused sales to increase further. The sharp selloff then caused panic selling to ensue and stops to be triggered. Monday’s selloff in crude oil appeared very similar, as 10,000 contracts were traded in the space of one minute at times. We would think now that as the selling abates and appears to have “gone away,” that bargain-hunting may enter the trade and cause prices to move higher.