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Oil could get slammed by slowdown in this region

Crude oil prices surged above $50 per barrel, last week with WTI hitting $51.62, but they may have peaked.

The recent rally in prices has already drawn in some U.S. shale producers, desperate to generate revenue, after the past year's price and production declines.

Just last week, Harold Hamm, CEO of Continental Resources said that his company was putting wells that had been previously drilled, but not completed, into service, and both the U.S. rig count and overall U.S. domestic production has seen a small rise over the past two weeks, according to U.S. government data.

The real Achilles heel of the oil market remains the key demand center of Asia.

China, Japan, and South Korea are experiencing real slowdowns in their economies, citing a poor export environment for their respective products, as the primary cause.

Some of the recent economic data points have starkly shown the magnitude of the slowing. In Japan, machine tool orders have been down over 20 percent, each of the past two months, on a year-on-year basis, and on June 12 it was reported that Chinese investment in fixed assets fell to its lowest level in over 15 years.

The South Korea central bank cut interest rates last week, in response to slowing conditions, and we are all aware of the massive monetary efforts being undertaken by the Bank of Japan, in an attempt to get the economy there off its back.

One bright spot for the crude oil market was thought to be Chinese demand, which recent trade data showed was strong. However, much of those imports are either going into strategic storage basins or going to feed so-called 'teapot' refineries that have sprung up, to such a degree, that China has become a net exporter of refined fuels, due to the fact that China now produces 150 percent of its fuel requirement.

China appears to be doing to the global refining industry what it has done to global steel industry: over supply the market.

The production rebound in the U.S. is minimal, but it looks to have stopped the trend of production losses from last year. Over the past twelve months, U.S. crude oil production is down over 850,000 barrels per day, which is a significant amount.

Recently, a series of various, unrelated supply outages ranging from Canadian wildfires to the Kuwaiti oil workers' strike to civil strife in Libya and Nigeria combined to reduce daily, global over supply significantly. But with the exception of Nigeria, those situations have either resolved or are in the process of doing so.

Over the course of the summer, we will lose the demand provided by the strategic oil purchases by the Chinese government and the peak U.S. summer driving patterns.

We also may have to deal with the tumult and bunker mentality caused by a vote of United Kingdom citizens to leave the European Union, which will further undermine confidence in the fortunes of the global economy.

With the Federal Reserve readying an interest rate hike, at some point this year, the dollar's rise seems inevitable, adding to downward price pressure on commodities, including oil.

Oil prices have made a quite a climb, since February, but further gains face a very challenged environment from the supply, demand, and currency front in the months ahead.

They are much more likely to retest the $40 per barrel mark by end of summer than have much more upside.



Commentary by John Kilduff, a partner at Again Capital, an investment-management firm that specializes in commodities. Follow him on Twitter @KilduffReport.

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