Crude gets vulnerable on EU concerns

Crude oil prices on the NYMEX slumped sharply in the last week, touching a low of $68.85/bbl. Prices suffered a setback on the back of fiscal issues in the Euro Zone which could stifle global economic growth and also lead to lower demand for crude oil. This factor coupled with rising inventories in the US, the world's largest energy consumer is also leading to downside pressure on the commodity. Strength in the Dollar Index (DX) is additionally adding to downside pressure on crude oil which lost 18% in May.

Crude oil inventory data in the last week came on the bearish side as the US Energy Department  reported a rise in crude oil inventories by 900,000 barrels to a record 37.9 million barrels in the week to 14th May. Crude stored at the delivery hub in Cushing, Oklahoma rose 500,000 barrels in the week to 18^th May. This inventory data is bearish and continuing rise in inventories pose concern.

Fear of growth in oil demand grips markets

Markets are currently facing a hazy scenario. On one hand, positive economic data from the US is boosting sentiments. But on the other hand, US crude oil inventory data is negative and has failed to give a clear indication of growth in the world's largest economy. Ongoing concerns in the Euro Zone coupled with concerns of monetary policy tightening in China will continue to weaken risk appetite. Even if buying support comes in at lower levels, the overall trend in crude oil remains down. Europe's debt crisis could hurt global economic growth and slow energy demand. We also expect a slowdown in energy demand from China as the country may go on for further monetary policy tightening.

Factors affecting crude oil prices:

·         The grim economic scenario in the Euro Zone has led to concern over consumption of energy.

·         Combination of news from China and the EU debt crisis has created a scenario that markets have been dreading.

·         Chinese growth may slow as Chinese officials may have to raise capital and lending requirements further to stem price inflation as the Chinese economy is overheating.

·         Stronger DX on the back of worries in the EU.

·         Greater downside risk on the back of EU sovereign debt crisis and decrease in EU GDP.

·         Risk aversion in the markets is expected to stay on the back of forthcoming EU policy and structural decisions, success or failure of austerity drive in southern Europe, and further downgrades of debt ratings.

·         We expect the Euro to weaken on the back of these issues. Loss of risk appetite coupled with apprehension about a government induced slowdown in the Chinese economy could further keep a check on oil prices in the short-term.

Fundamental Outlook

Risk aversion in the financial markets is expected to remain. Even if we witness short period of optimism, it is doubtful that it will last long as long term effects of the European debt crisis on the global economy are expected to be negative. Crude oil is currently battling with rising inventories in the US on one hand and grim economic situation in the Euro Zone on the other hand. On the back of these issues, oil prices are expected to trade with a negative bias in the coming week. Even if the weekly opening happens in the positive territory, we expect risk aversion to re-emerge and lead to lower demand for higher-yielding and riskier investment assets in times of financial uncertainty.