When it comes to the price of oil, both the sellside and oil producers have been adamant that the only variable that matters is supply, i.e., how much oil is produced at any given moment which was also the justification behind the Vienna production cut deal: reduce supply enough, and the record global inventory glut will decline by bringing markets into equilibrium, boosting prices in the process. Alternatively, another explanation has been the recent liquidation of oil positions by speculators (read hedge funds), who tend to amplify moves in the world's most financialized commodity. Indeed, the sharp move lower over the past three weeks was largely attributed to selling be levered entities who unable to push the price of oil higher, had no choice but to take the other side of the trade.
Throughout this, one aspect of price formation that is rarely mentioned is demand, which is generally assumed to be unwavering and trending higher with barely a hiccup. The reason for this somewhat myopic take is that while OPEC has control over supply, demand is a function of global economic growth and trade (or lack thereof) over which oil producers have little, if any control.
And yet, according to the latest oil price dynamics report issued by the Fed, it was declining global demand that pushed prices lower in the most recent, volatile period.
As the New York Fed report in its March 27 report, "Oil prices fell owing to weakening demand" and explains as follows: "A decline in demand expectations together with a decreasing residual drove oil prices down over the past week."
While there was some good news, namely that "in 2016:Q4, oil prices increased on net as a consequence of steadily contracting supply and strengthening, albeit volatile, global demand" offsetting the "modest decline in oil prices during 2016:Q3 caused by weakening global demand expectations and loosening supply conditions," the Fed's troubling finding is that the big move lower since 2014 has been a function of rising supply as well as declining demand:
Overall, since the end of 2014:Q2, both lower global demand expectations and looser supply have held oil prices down.
And while this trend appeared to have reversed in 2016:Q2 and 2016:Q4, recent indications suggest that demand may once again be slowing, which in turn has pressured oil prices back to levels last seen shortly after OPEC's Vienna deal.
The Fed shares the following decomposition table on imputed supply/demand recent data:
It is curious that according to the NY Fed, at a time when OPEC vows it is cutting production, the Fed has instead found "loose" supply to be among the biggest contributors to the latest decline in oil prices.
But what may be concering to oil bulls is that as the decomposition chart below shows, while oil demand was solidly in the green ever since Trump's election victory, in recent weeks it appears to have also tapered off along with the supply contribution to declining oil prices.
This seems to suggest that along with most other "animal spirits" that were ignited following the Trump victory, only to gradually fade, oil demand, and thus price, may be the next to take another leg lower unless of course Trump manages to reignite the Trumpflation trade which, however, over the past month appears to have completely faded. Finally, in an environment of rising interest rates, and with Obamacare repeal delayed indefinitely - which as a reminder will soak up potential discretionary spending on other goods and services - one can argue that the decline in demand observed going into last year, coupled with a potential disappointment from the failure of Trump to implement his full fiscal policy, the decline in demand will only accelerate in the coming weeks.