Crude oil is holding steady at $80 per barrel (Brent crude) in the aftermath of the disappearance of Saudi journalist Jamal Khashoggi and calls for Saudi Arabia to explain the situation. We anticipate volatility to continue in the commodity near-term on the back of this serious geopolitical issue.
However, some experts think this pricing environment will be short-lived. During a Bloomberg interview in London at the Oil & Money Conference, Ian Taylor, chairman of Vitol Group, one of the largest privately held crude oil traders, issued a bearish statement on oil prices, suggesting that the commodity could trade $10-$15 lower per barrel from current prices by 2019, rather than trading up. Taylor sees the recent oil rally as a "fear factor" rather than a supply issue.
Taylor bases his forecast on two premises: there's already plenty of oil available in the market and as crude oil rallies there could be demand destruction, particularly from emerging economies that are sensitive to commodity prices and currency fluctuations. We agree with the second argument which has been widely covered in the media; however, the first item is what most participants debate.
Vitol has reduced its global demand growth forecast for 2019, leaving the question on whether the pipelines hauling crude oil from the Permian Basin will manage to boost transportation capacity then. As we mentioned in our column, one of key concerns among energy traders is that pipeline takeaway capacity for oil and gas to markets outside the Permian could be insufficient for the region's strong growth in oil and gas production for much of 2019.
A report by Moody's mentions that new pipelines will likely go into service at various times in second half 2019, alleviating the bottleneck. But until then capacity constraints will likely limit producers' activities, which in turn could put a cap in crude oil prices, at least in the U.S. where there's a $10 a barrel discount from Brent, the global benchmark.
In the Permian Basin, large oil producing companies like Pioneer Natural Resources (PXD) , Concho Resources (CXO) , and Diamondback Energy (FANG) , all hold contracts that cover all or most of their anticipated production for 2019. However, small companies, such as Laredo Petroleum (LPI) , Jagged Peak Energy (JAG) , and Endeavor Energy Resources LP, lack direct transportation contracts for 2019 with pipelines, raising their risk of capacity shortfalls and leaving them vulnerable to any price drop.
Although small producers can still sell their products through other means (trail or truck) and hedge the price differentials between Cushing, Oklahoma and Midland, Texas, this lack of contracted capacity could leave producers vulnerable to capacity shortfalls in 2019.
According a report from the Wall Street Journal, the option markets indicate that traders are positioning for a further rally in crude oil prices. But Vitol is assuming that a dramatic fall could ensue. Using data from the InterContinental Exchange, the number of January $100 per barrel call options has more than doubled since the beginning of September.
While there is some validity to Vitol's claims, until we see a clear indication of weakening demand or adequate supply of crude oil, it is very difficult to put a short position at this juncture as we think the trend is upwards.
For equity investors looking to play the options market, we recommend buying January $100 BNO Calls, which is the United States Brent Oil ETF, which tracks the front-month futures contract for Brent crude oil. These calls have the greatest open interest among the January-dated ones.