Monday, August 24, 2015

Crude Tumbles, Law of Small Numbers

We resume the financial week with stock losses to add onto the market correction in both the United States and China. The numbers explain it better than I do. China's Shanghai Composite Index dipped 297.84 points to 3209.91 (a -8.49% loss). The Dow Jones Industrial saw losses up to 1000 points in reaction to the Chinese rout but are settling down about 200 points instead. The 1.5% loss comes after a 500 point loss at the end of last week. Dow levels below 15,000 accompanied by Chinese recession threats since the devaluation of the yuan send investors' memories to crashes in the past with a BBC reporter comparing today to the flash crash in 2010. The stories don't stop there. Oil and gas investors will be worried more as the WTI and Brent crude benchmarks extend prolific losses on the day amidst the global market conundrum. A little bit over halfway on the day, WTI stands at $1.17 or -2.92% and Brent maintains a loss of $1.55 or -3.34% attempting to recover larger losses that occurred at opening.


Another thing worth noting is the closing of the spread between WTI and Brent prices. Oversupply issues are still concentrated in the United States with global repercussions, but weak Chinese demand is felt more on the international stage than in Cushing. Asian imported crude oil originates in the Brent and OPEC markets; therefore, lower projected consumption would hurt those benchmarks more. Coupled with the possibility of American exports, the Brent price should experience more significant drops as global volatility takes the reigns in the markets. It is possible that the spread only existed due to speculation that U.S. energy markets differed from international markets, but belief in that idea will be crushed in the slump. As the North Sea slows in production, U.S. exports could be the key crude supply five years down the road. The Shanghai Index is shown in the chart above which plots price movements over the past month in China. It may be that a simple correction of the market is in play, checking national economies worldwide, but failing to hurt their integrity. Energy investors will be looking at OPEC and their response to the Asian crashes as their Middle East constituents have become major exporters to China, India, and Japan. Demand potential could be another reason for a spread between the WTI and Brent benchmarks which have similar attributes. The Chinese and Indian emerging economies have had projected growth beyond the typical 3% bolstered by traditional growth economics. The potential of fueling cars for a third of the population as well as new economies in Africa, which will not be looking at alternative fuels just yet, is always in the back of the mind when Brent is traded. WTI futures contract come with the stipulations of the North American economy which typically post decent growth numbers. Then the law of small numbers come in. Investors looking at total global demand outside of the United States should remember that statistics will have smaller standard deviations and be closer to the center due to the large sample. The North American economies consist, for the most part, of Canada and the United States (which are typically connected). WTI speculation about projected demand, as well as demand statistics, will be more volatile because of the likelihood of extremes. This should speak to all commodity investors concerned with demand in different parts of the world. For the rest of the week, investors should continue to watch the Chinese stock market and how it puts pressure on U.S. securities as well as bearish movements from WTI and Brent which could drop another $2.00 by the end of the week.

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