Back when I was still an awkward teenager in the 70s, the International Energy Agency (IEA) was established to help countries deal with disruptions in oil supply by releasing some of its own black crack stash. As an organization in charge of ensuring the quality and affordability of oil, the IEA decided that it was about time they do something about recent rise in crude oil prices.
Last week, the IEA announced that its 28 member countries would release 60 million barrels of crude oil in the markets to keep prices from rising. Uncle Sam will cover half the tab, while Japan, Germany, France, Spain, and Italy would take care of the rest.
The IEA’s plan is to release 2 million barrels of crude oil each day for the next 30 days as they expect oil supply to keep dwindling in the near term. They explained that the recent unrest in Libya resulted in supply chain disruptions, which eventually triggered a spike in prices. In fact, they estimate that Libya probably cut off a total of 132 million barrels of crude oil from the markets as of May.
If crude oil supply keeps falling, this would be very damaging to the global economy. You see, black crack is the blood that runs through the veins of the world economy because it is the main source of energy. Without it, we might just see a huge drop in production and overall growth!
Several oil producing countries (Saudi Arabia, Kuwait, UAE, and Qatar) already saw this potential downturn coming, which was why they volunteered to increase their own oil production. However, as I discussed recently, the Organization of Petroleum Exporting Countries (OPEC) turned down this offer as they worried about a possible collapse in oil prices.
Back then, Saudi Arabia defiantly decided to raise its own production just the same. And now, the IEA decided to join in by pouring some of their reserves into the world market pool!
Upon the release of the news last Thursday, we saw oil prices drop across the board. Brent crude, which is more heavily traded in European markets, dropped by as much as 7% in intraday trading. Meanwhile, WTI crude hit as low as 89.70 before settling at 91.725, marking a near 3% decline.
No surprises here – it’s all about supply and demand, my dear Watson! With news coming out that more oil would be available, it’s only natural that we saw decline in oil prices.
Meanwhile, over in the forex market, we saw a huge dollar rally, as risk aversion took over. While a majority of the move was due to poor economic data released across the globe, I believe that part of the move was also fuelled by the sharp decline in oil prices. Oil is a benchmark commodity, so any time we see a drastic drop in oil prices, chances are that we’ll see a similar sell off in other markets as well.
Looking ahead, I can’t help but feel that this was just a temporary knee-jerk reaction to the news. Traders were probably just readjusting their positions. Demand for oil, particularly in Asia, is strong, so we shouldn’t see too drastic of a drop in oil prices.
Once the markets price in the additional supply, I feel that we’ll find risk sentiment continuing to drive European currencies. Meanwhile, comdolls like USD/CAD and AUD/USD should continue to find nice support as commodities remain resilient.
In any case, let me remind you to always stay on your toes. As a good friend always tells me, we live in unprecedented times, we just don’t know what might happen next!