Oil production crash fatal for stock market rally

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  • The number of active US platforms fell to an 80-year low in May.
  • But a shortage of storage capacity will keep oil prices capped.
  • And the reduction in output is a distressing signal for GDP and the stock market.

The stock market rally seems unstoppable as the global economy begins to reopen. But the latest reading of a critical leading indicator of future oil production shows that the recovery may be premature. If the economy contracts as much as production suggests, stocks could be destined for another correction.

Oil production in the United States has fallen to its lowest level, according to data released by the energy services company Baker Hughes Co. The company has had weekly active US platforms since 1940. The tally provides a leading indicator of future production.

The number of rigs dropped by 34 to a record low of only 374 active oil rigs. In the first week of May last year, that number was 988, so this week’s tally represents a 62% year-on-year collapse on the other active platforms.

But don’t expect falling production to drive prices up for a long time. There is still a massive glut of supply and virtually no capacity to store new crude oil production.

Storage shortage to cap oil prices

Oil price per barrel of Brent crude oil, the international benchmark (YTD) | Graphic: TradingView

While hopes of reopening the economy are boosting the stock market, rising oil prices in the first week of May also gave a boost to stocks. But analysts warn stock markets not to get too excited about oil prices

.

Nicholas Cawley, market economist at Dailyfx.com wrote in a note on Wednesday:

The first month WTI oil futures will continue to be volatile until the storage problem is resolved and traders are confident that if their position expires they will be able to store oil at a reasonable price.

He added that the excess supply will remain unused for the foreseeable future:

World economic activity is unlikely to recover in the foreseeable future, demand for oil will remain weak, and the current imbalance against excessive supply will continue to limit any recovery in WTI’s oil futures.

Last month, West Texas Intermediary, the American benchmark for the price of a barrel, cratered in negative territory for the first time. A week later, Paul Sankey, an analyst at Mizuho Bank, warned that oil could drop to $ 100 a barrel in May.

Oil production reveals sparkling stock market rally

1YR Chart showing the correlation between the stock market (S & P500 index in red) and oil prices (Brent Crude in blue) | Graphic: TradingView

The stock market was closely correlated to oil prices in the months leading up to the COVID-19 panic. The stocks appeared to be inspired by the crude markets.

In the last six months of 2019, the two markets moved in tandem, with stocks lagging slightly behind oil. Strategists observed the crude market to assess the risk of recession for future economic growth.

Julian Emanuel, head of equity and derivatives strategy at BTIG, said in January:

Inventories were much less of a leading indicator and more of a simultaneous indicator than they usually are. Oil has really found itself in the same current of geopolitical uncertainty. The price of oil tells you that there will be no recession. It strengthens. For me, this is the stock transmission loop.

Falling production and historically low prices are a distress signal for the global economy. The stock market continued to recover during the 2014 oil crash as GDP increased. The barrel crashed as the United States, Canada and Saudi Arabia increased production.

But today, there is a massive glut of supplies as the oil industry returns production to its historic lows. Meanwhile, GDP is in sharp contraction.

This will have a direct impact on equity market benchmarks through energy sector stocks, as a debt-laden energy sector faces a sustained demand shock. In the meantime, it is a global leading indicator of a depressed economy.

So do not look at oil prices and do not expect the stock market recovery to last.

Disclaimer: The opinions expressed in this article do not necessarily reflect the views of CCN.com. The above should not be considered as investment advice from CCN.com. The author has no investment positions in oil or US stocks at the time of writing.

This article was edited by Aaron Weaver.

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