Yesterday when the yuan had weakened almost 2%, the slide in commodity prices was cited as evidence of the market’s concern that China was going to export deflation.  This weighed on the dollar-bloc currencies, and the currencies of other commodity producers.  Today the yuan has fallen further, oil prices are higher as are the dollar-bloc currencies and the main commodity producers in the emerging market space.

To attribute everything to China is to make analysis superfluous.  Take a look at oil.  China’s trade report last weekend showed oil imports in volume terms increased.  Oil prices have stabilized today after the sharp sell-off yesterday.

Many attribute the decline in oil prices this week to China.  This makes is a demand story.  Yet, the pressure was coming from the supply side.  Specifically, the largest refiner in the US Midwest, which can process 250k barrels of heavy crude a day, had to shutdown due to leaking pipes.  This oil that could not be refined is adding to the oversupplied markets.

Moreover, with the numerous pipelines, the extra appears to be primarily from Canada’s tar sands.  The benchmark is Western Canada Select.  Today is the tenth consecutive session that prices for it are lower.  It is now  trading near $23.50 a barrel.  Canadian oil has not been this cheap since the end of 2008.   This is a nearly 58% decline since early June.

Canada’s oil from the tar sands is expected to increase by 6% this year to 2.3 mln barrels, according to reports citing the Canadian Association of Petroleum Producers.  Unlike US production, output from the tar sands require longer lead times and are not as easy to shutdown.  In addition, the high fixed costs associated with such production encourages continued production, even if at a loss.  Saudi Arabia’s strategy of stepping up output to drive the price lower is working, but it is not having much impact on North American output.

There has been much focus on the Keystone XL Pipeline between the US and Canada.  Many observers have missed the fact that other pipelines have created more capacity in the US for Canadian oil.  The network of pipelines has also boosted efficiencies.    The Canadian election in mid-October may also keep the formal US decision on the Keystone Pipeline in abeyance.   The New Democrat Party challenger to Harper, Mulcair, has campaigned against the pipeline.

Note the US dollar has been trending lower against the Canadian dollar since peaking last week near CAD1.315.   Since last Wednesday, WTI has fallen four dollars a barrel at yesterday’s lows.   The price of Western Canada Select crude has fallen from $29.35 to $23.27 yesterday.   Be careful trading based on (unstable) correlations.

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