The Top 4 Reasons Why Oil Prices Fell

In the last two weeks, the price of WTI crude oil has been experiencing a massive decline. After it had topped out at 114.86, it dropped more than $20 to hit levels it hadn’t reached in more than a month. Just take a look at this chart:

WTI Crude Oil Chart

There was a lot of speculation as to why it dropped, but I believe it was just a snowball effect due to a combination of factors. Here are the 4 reasons why I think oil prices fell:

1. Concerns about the global economy could dampen oil demand in the future

In terms of economic data, major economies have posted somewhat disappointing results. In the U.S., the most recent employment report revealed that joblessness in the country rose to 9.0% in April after it had fallen back to 8.8% in March.

In the euro zone, sovereign and debt problems came back in the limelight as Greece’s credit rating got downgraded to BB- from B. There were also rumors that Greece may have no choice but to restructure its debt.

Another cause of concern was that the most recent German manufacturing orders report. The market expected a 0.4% increase, but the report showed a whopping 4.0% decline instead.

2. Subsiding geopolitical tensions in the Middle East

While the civil unrest in the Middle East and North Africa (MENA) has been messy, the tensions have generally subsided from its peak two months ago. During that time, oil prices rose around $15-20 a barrel. But now that the risk of a major disruption in oil supplies has faded, it only makes sense that oil prices have fallen back to its pre-unrest levels.

3. Monetary Policy Tightening by China and India

A major reason why oil had been soaring up the charts was due to demand. Nope, not European or American demand, but Asian demand!

Okay fine, I’ll admit, I’m really just talking about China and India. The two countries are the biggest oil importers in the Asian world, which sounds right, considering that their respective economies have been on fire.

However, with the recent run of commodities sparking concerns about inflation, the People’s Bank of China and Reserve Bank of India have responded with the only way they know how – rate hikes! The PBoC has repeatedly raised interest rates and the reserve requirements of Chinese banks over the past four months. Meanwhile, the CBI also raised interest rates by .50% last May 3, bring rates up to 7.25%.

These hikes, in addition to more monetary policy tightening down the road, have probably cut into demand for oil, causing oil prices to dip back slightly.

4. Commodities Margin Increases

Lastly, the rise in commodity margin requirements, most notably in silver futures contracts, probably contributed to the decline in commodity prices.

While the increase in margin requirements for WTI crude wasn’t as much as silver’s, the increase still had a negative effect on oil trading. The reason for this is because when margin requirements are raised, traders are less financially equipped (i.e., they got no money to put up for margin), forcing them out of the futures market. This probably caused some traders to close out their positions, which contributed to the sell-off in oil.

When you combine all these reasons, what do you get? A nice dip in oil prices!

The question is whether these factors will become recurring obstacles down the road. Is this the start of a major drop in oil prices similar to what we saw in 2008, when oil prices fell from a high of 147.23 all the way back down to 33.15? Or is this a small pullback and the overall trend is up?

What do you guys think? Lemme know on the comments section down below!

  • PaddyB

    Great commentary!  But, I am very new to learning fundamentals and am a little confused. Why would the increase in German manufacturing orders report have a negative impact on oil prices?  (Hopefully not a really dumb question!)

    • huck

      I’m not an expert either, but I think the disappointing result of the German manufacturing orders showed that Germany, the country with the largest economy in the euro zone, isn’t doing that well! Germany’s economy relies heavily on manufacturing and exports.

      • ccfeldt

        “Another cause of concern was that the most recent German manufacturing orders report. The market expected a 0.4% increase, but the report showed a whopping 4.0% decline instead.”
         
        Numbers were much worse than expected.

  • Paddy B

    Duh!  I am a totaly knucklehead!  I had read an “incline” in orders!  So that is why I was totally confused!  Thanks  :) 

  • FX junkie

     I doubt this is the start of a freefall drop in oil prices. In fact, I believe this is a fair & healthy correction for oil prices which has risen dizzyingly high in recent months!

    It seems that there’s going to be a MACD bullish crossover soon …prices seems to be consolidating now (seems like a lot of buy orders at $95) If oil can close above $100 2 days in a row, I think that’s a bullish signal for cheap dollars to flow into oil.

    note: I’ve just started trading FX recently & i think this is a great website to learn & share ideas! Keep it going guys!