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A 'Perfect Storm' Could Cause A Collapse In Oil Prices That Hits The Stock Market Too

oil barrels in a storm
oil barrels in a storm

flickr/Adam Selwood

Deutsche Bank strategists Rocky Fishman, Salil Aggarwal, and Lon Parisi are out with a note warning clients that a "perfect storm" of structural, demand, and supply-driven factors could conspire to cause a "major pullback" in oil prices, with the potential to derail the rally in the U.S. stock market as well.

"A major pullback in oil prices could have a concentrated effect on the S&P energy and industrials sectors, with perhaps further sentiment knock-on effects," write the strategists. "After WTI's brief pullback from its peak last month, it may be time to at least consider this possibility."

West Texas Intermediate (WTI) crude oil prices have rallied from a low of $84.05 a barrel on November 7 to $106.88 at Friday's close, returning 27.2% over the past nine months.

"Oil is now, according to our commodities team, the most richly traded commodity in the world in real terms after massive appreciation over a multi-year horizon," says the Deutsche Bank team. "However, structural, demand-driven, and supply-driven catalysts exist for a near-term pullback – and a 'perfect storm' of a multiple of these factors could cause an even more significant move."

Fishman, Aggarwal, and Parisi bullet the three factors that could come together to cause a perfect storm for oil prices:

  • Structural: Falling inventory levels in the Cushing complex start leveling off or even turning up – whether driven by increased Bakken-to-Cushing transport or infrastructure concerns. The huge net long speculative futures position also could set up downside volatility if unwound.

  • Demand: Another leg down in China growth impairs Brent pricing, or US economic data disappoint and limit demand for WTI. Low refining margins are indicative of weakening demand.

  • Supply: Most supply events would be bullish oil, but we wonder if resolution of one or more stress points (e.g. the incoming Iranian regime negotiates an end to its embargo) could materially drive up supply.

Deutsche Bank chief U.S. equity strategist David Bianco hiked his year-end price target for the S&P 500 in mid-July, citing "recent WTI oil price strength despite the climb in Treasury yields and the dollar."

Bianco also spelled out the logical inverse of his call: " A surge in yields or oil price collapse has long been the chief risks to our strategically bullish view."

Fishman, Aggarwal, and Parisi say Bianco "sees [the S&P 500] as always long oil."

"As a weak [S&P 500] ex-financials quarter unfolds, we are starting to believe further 'earnings power bad news' could make the market revisit its recent multiple expansion altogether," write the strategists. "This could doubly impact selected energy names, so we think that hedges in the energy complex – services, [exploration and production], integrateds – may be especially efficient going forward. In a sense, the [S&P 500's] overall multiple could start to be weakened by the oil complex’s earnings potential."

The Deutsche Bank team stresses that it is in fact bullish on oil in the near term, but says low price volatility in both oil and energy sector equities makes now a good time to hedge those bullish bets, given the structural, demand, and supply-driven factors highlighted in the note.



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