Oil prices have been nose-diving, and one chart explains why

Myles Udland
Markets Reporter

In recent weeks, amid relative calm in the stock market, oil prices have slid back to their lowest level in a year. On Wednesday, WTI crude oil, the U.S. benchmark price fell to $42.13 a barrel, hitting its lowest since August 2016.

And it’s all about the most basic principle in economics: supply and demand. In the global oil markets right now there is simply too much supply.

This week’s slide came, counterintuitively, after a report earlier in the day which crude inventories fell more than expected. A decline in inventories would be seen as a good sign for oil prices stabilizing — or even rising — as low prices have been blamed on a glut of supply.

But as the chart below from Bespoke Investment Group shows, crude oil production in the U.S. is now back at its highest levels since 2015 and at its highest in the U.S. since hitting a post-oil crash low late last year. And as long as production continues ramping in the U.S., no amount of coordination from OPEC members or other state-sponsored oil producers is likely to bring markets into balance.

Oil production in the U.S. is on the rise again. (Bespoke Investment Group)

If we go back to the early days of the oil crash back in the end of 2014 and beginning of 2015, concerns centered on whether the decline reflected a lack of consumer demand or oversupply. Ultimately, it became clear imbalances in global oil markets were to blame for the decline in prices, stoking worries over the financial health of energy companies and their debt loads.

And while low oil prices are a continuing boost for U.S. consumers, worries about low prices creating problems for energy companies have started to creep back into the market

“The ripple effects [of the recent oil slide] are starting to come to the fore,” writes Gluskin Sheff strategist David Rosenberg, “with the energy debt markets playing catch-up to the beaten-up stock market segment.

“The average yield on High Yield energy bonds has jumped 80 basis points this month to 7.14%, and at some point when the credit taps for the marginal buyer get turned off, we will see a bottom in the price.”

Rosenberg adds that while fringe U.S. producers don’t need $60 per barrel oil prices to make their debt manageable, they do need $50.

“Finishing up with the oil story, the lingering problem remains one of supply,” Rosenberg writes. “U.S. inventories are some 100 million barrels above the five-year average and this was not expected three or six months ago as the consensus was that we were well on our way towards achieving global supply-demand balance.”

And while oil prices may bounce from current levels, a long-term rise in oil prices will simply not be sustained until this imbalance is worked out.

Myles Udland is a writer at Yahoo Finance. Follow him on Twitter @MylesUdland

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