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Oil breaks below $40/bbl on demand concerns, improving supply.

Date: 10-09-2020
Subject: Oil breaks below $40/bbl on demand concerns, improving supply
Ravindra Rao

After days of rangebound movement, crude oil price has slipped below the key $40 per barrel and tested the lowest level since late June.

Crude oil was bound in a range for the last few weeks owing to mixed factors both on demand front as well as supply. Price however benefitted from general strength in equity markets and weakness in the US dollar.

Crude weakened sharply in the last few sessions amid first signs of correction in the US equity market. The US DJIA index ended lower for a second day Friday marking its biggest fall since June.

Equity markets have been riding high on expectations of continuing economic recovery amid continuing stimulus measures and on signs of progress in vaccine development.

The rally however showed a delink between actual economic health and market perception and this resulted in the much anticipated correction in equity markets.

Global economic outlook remains challenged by rising virus cases globally, uneven economic recovery, increased US-China tensions and delay in additional stimulus by the US.

Crude along with other commodities came under pressure as the US dollar index attempted another recovery from 2018 lows. The US dollar benefitted from ECB's concern about euro's strength, mixed European economic data, rising virus cases in parts of Europe and Brexit uncertainty. The rise in the US dollar has come also amid positioning ahead of ECB's next monetary policy meeting as the central bank may maintain a cautious tone.

Apart from macro factors, crude oil is also pressurized by rise in OPEC's production, recovery in crude oil production in the Gulf of Mexico region post shutdowns caused by storm activity, slower Chinese crude imports and Saudi Arabia's move to reduce price for Asian customers in wake of weaker demand.

Crude oil was struggling for direction and a break below the $40 a barrel level has paved way for additional losses. However, a sustained decline may come only if US equity markets continue to slide or if we see a sharp rise in the US dollar. Fed's dovish stance may also limit any major upside in the US dollar. Amid other factors, crude oil may benefit from continuing decline in US crude oil stocks which shows a tighter market.

The author is VP - Head Commodity Research at Kotak Securities.


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