Rain in Spain weighs on risk sentiment and oil prices

Oil prices have plunged by almost USD 6/barrel to Brent USD 102.94/barrel and WTI USD 88.32/barrel since Thursday afternoon’s high as Euro-zone fears once again weigh on risk appetite, just like grey and rainy clouds cover the bright and warm summer sun in Northern Europe. The resurgence of fear triggered a sell-off of riskier assets such as oil as investors took flight into safe-haven US Treasuries.

The return of Euro-zone uncertainty came after news that two Spanish regional governments, Valencia (Friday) and Murcia (Sunday), have sent bailout requests to the central government in Madrid and pushed Spain’s bond yields to a new euro-era high (10Y at 7.52%) and the euro to a 2-year low against the US dollar at 1.2103.

Market fears were driven even higher Friday after the troika (the IMF, the ECB and the European Commission) ramped up the pressure on Greece ahead of a visit by international lenders this week by refusing to accept Greek government debt in exchange for central bank funds for the time being. The statement has renewed doubts that Greece can fulfil its obligations to the creditors and added to the risk that new funds will not be made available if the commitments are not met.

 Source: Reuters Ecowin

Worries are also increasing about the economic growth potential for China, the world’s second-largest oil consumer. According to Bloomberg a Chinese central bank adviser predicted that China’s GDP growth may fall to 7.4% in Q3 as the Euro-zone crisis has dampened exports and a crackdown on property speculation has curbed domestic demand. We still expect China’s aggressive stimulus measures to come into effect over the coming months and that the recovery will occur gradually this autumn. Early tomorrow morning we will get further indications of recent developments in the Chinese economy as the HSBC flash manufacturing PMI for July will be released.

Political turbulence, embargo/sanctions against Iran and planned maintenance continue to support prices.

The escalating conflict in Syria has raised the prospect of a collapse of the Syrian government and concerns over a further eruption of violence. Around 170k b/d of oil flows remain shut in due to the political unrest and sanctions, and this oil is not likely to return to the market for a while. The intensifying conflict in Syria coincides with a surge of violence in neighbouring Iraq.

Violence has escalated in Iraq in the last few days following a series of attacks by unidentified gunmen targeting a military base and detonating car bombs in cities such as Baghdad and Kirkuk. Increasing political stability may put new oil production and infrastructure projects at risk. In addition, political progress remains stalled over the Kurdish-Baghdad oil disputes. The Kurdistan Regional Government (KRG) continues to push for independent oil exports and this has strained Turkey’s relationship with Baghdad as Turkey continues to import Kurdish oil.

The EU oil embargo against Iranian crude imports and tougher sanctions by the US continue to work on the countries’ oil supply. We expect that Iranian oil exports will fall by 1-1.3m b/d in July. Nevertheless, Iran is ramping up its shipments to China. According to Bloomberg Iranian shipments increased by 17%m/m in June to around 635k b/d. The average import from Iran in 2011 was 557k b/d.

European oil supply is still affected by the Norwegian oil strike that shut in around 240k b/d of North Sea oil production in the period from 24 June to 10 July. North Sea exports are expected to drop to the lowest levels in 26 months in August as planned maintenance will cut export volumes by around 27k b/d to 1.91m b/d (Bloomberg).

Political unrest will continue to support oil prices in Q3 with mounting fears of what will happen in Iran and Syria, but the all-important this week will be the rain in Spain and risk of rain in other troubled European countries.

Key indicators to look out for this week will be growth signals from China, with the HSBC PMI (Tuesday morning), the German Ifo index (Wednesday) and the US Q2 GDP data (Friday).

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