Dallas Fed warns oil market won't stabilise this year

Jessica Morris
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U.S. Federal Strategic Petroleum Reserve
Energy sector turmoil could spread to the wider financial market (Source: Getty)

The Dallas Fed chief said the oil market won't rebalance this year, as he warned persistent weakness in the energy sector could send "negative ripples effects" through financial markets.

Robert Kaplan, Dallas Fed president, said demand and supply won't balance until mid-2017, however this could change if the Organization of the Petroleum Exporting Countries (Opec) alters its production strategy.

"This forecast has been influenced over the past several months by the official return of Iran to the world oil markets, increased supply from Opec nations, slower-than-expected supply declines from US producers despite substantial cuts in drilling and capital spending, and slower-than-expected demand from emerging-market countries," Kaplan told an audience at the University of Texas yesterday.

"This outlook would be meaningfully impacted by a change in OPEC production strategy," he said.

In February, Opec members Saudi Arabia, Qatar and Venezuela and non-Opec Russia agreed they would cap production at January levels if other oil producing countries followed suit.

Some investors have taken the preliminary agreement as a sign that the countries could later reduce output to clear the global supply glut that has forced down prices.

Kaplan also warned there's a risk of energy sector turmoil spreading to the wider financial market if investors pull their money out of funds which are heavily exposed to bad loans.

"One by-product of lower oil prices is wider credit spreads in the high-yield market," he said.

"Because corporate energy issuers comprise a material portion of high-yield issuance, and because highyield debt is heavily held in mutual-fund (with daily liquidity obligations) and exchange-traded fund form, weakness in the energy sector has the potential to create increased levels of fund redemptions."

"This, in turn, can put pressure on funds to sell holdings more broadly in order to meet liquidity needs. This is a good example of the potential negative ripple effects that can come from persistent weakness in the energy sector."

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