A thread that has held together markets from the 2009 low is being exposed and unwound. That thread is the price of oil and the story of those who benefit from oil as well as those who have the power to withstand low prices currently playing out as crude sits near seven-year lows. Of all the stories in 2016 that are likely to take up trader's attention like the Fed Hike path, China's Yuan pegging being removed to allow for more flexibility, and Emerging Market pain, the bear market in Oil will likely be front and center because of the implications of cheap oil.
Oil or energy is a core commodity and driver of inflation in economies developed and emerging. Many emerging market currencies and a handful of major currencies are heavily reliant on the price of oil for economic health. The price of petroleum is positively correlated to the strength of the economy, and in some cases is tied to the fiscal policy of the country.
The two-thirds cut in oil price from the 2011 high of $114 per barrel has had a drastically negative effect for economies like Canada, Norway, Russia, and many others.
Few economists on Wall Street are expecting higher prices in 2016, and a very pertinent question is how will these shaky economies weather another year of low oil prices if low energy prices in 2016 become a reality. The energy sector is tied to high-paying employment, which ripples positively throughout the economy. Some countries like Norway and states in America like Alaska, benefit very heavily when the price of Oil is high, and suffer when the price of Oil is low, as people tend to leave for other high-paying jobs.
On December 3rd & 4th, OPEC recently made a decision not to cut output.
A reduction in production or supply would have presumably helped stem the freefall in the price of Oil. On Thanksgiving in 2014, OPEC made a similar decision that caused Oil to fall 9% in one day and this year's decision has had a similar effect.
A week after the OPEC meeting, it was discovered that OPECs November 2015 Crude Production rose to three-year highs.
You’d be excused for being dumbfounded as to why production would be at record highs when prices are near the 2009 lows, where economies and companies are suffering because of the low price.
Currently, there is an obvious global surplus that weighs on prices. However, members of the oil cartel continue to pump and pump aggressively to help them balance the books, but there is an ancillary benefit that low oil prices could knock out some of their competitors outside of OPEC, such as those in the United States that are part of the “Fracking Miracle”. In other words, OPECs decision to keep pumping helps them balance their budgets for now while potentially pushing their competitors off the fiscal cliff.
The IEA recently stated that they expect the global oil surplus to persist through 2016 as OPEC maximizes production. The recent announcement of 1.5 million barrels per day being pushed into the market with decreasing demand means the current supply glut will take longer to work through them would have historically been the case.
If the IEA expectation comes to fruition, there could be further weakness in currencies whose economy is reliant on the price of oil. In this case, currencies like the Canadian dollar or Norwegian Krone could see a more severe 2016 than they did in 2015, which is hard to imagine given the pain they’ve already endured against strong currencies like the US Dollar. Some investors have looked to the corporate credit written on energy companies to see whether or not investors expect stabilization in the energy market or more pain. The recent route in high-yield energy though seems to see more pain on the horizon.
Until the components of production or demand change, it’s likely worthwhile to remain gloomy on the forecasts of oil and the currencies tied to the value of oil.