It has been two weeks after OPEC+ surprised the oil market during their monthly meeting by teasing the market they were thinking of raising oil production by 1 mbpd, to then surprising everyone 48 hours later taking off 1.5 mbpd out for the next month! Brent was trading close to $63/bbl. into this infamous meeting, then rallied all the way to $70/bbl. as Saudi Arabia seemed to get their way. Now it is back down to $63/bbl. So, what is going on in oil?
A lot has changed over the past few weeks, especially on the macro side. Since last November, most traders jumped in on the long oil trade to play the reopening, reflation trade as U.S. bond yields ticked higher on back of the global economy normalizing. As bond yields rose, this prompted others to join the long oil, value trade band wagon. Of course, winter was also picking up when demand typically rises. This new flood of money raised oil prices above and beyond what the fundamentals warranted. Of course, OPEC+, whose only agenda is to keep oil prices as high as possible to pay off their budget deficits, always tend to do what is extreme at the worst times. No one wants to play the smart long-term gain, but instead they focus on purely the short-term angle of getting prices higher to then see them fall later on. It would be easier to supply the market, keep prices low to completely kill off all the weak players who cannot survive, then the rally can be a lot more sustainable and long lasting.
Given the collapse of oil prices last year, U.S. shale suffered drastically. This year everyone has pretty much written them off saying they can never bounce back. The oil market memory is that of a gold fish as with all this easy money and free credit sloshing around, and banks are eager to lend once again as prices seem right. Now with Brent oil close to $70/bbl., we have seen about $20 billion of debt being raised by junk explorers to capture this opportunity. It is the same every single boom and bust cycle. This is why prices that move too fast are not good for the longer-term picture as weak players never get flushed out. The OPEC+ constant problem. If you look at U.S. rig count data, there is more oil coming in the future. Granted it may not be back to the 13 mbpd level, but the longer prices stay high, the more they will be incentivized, despite pledges to shareholders to be disciplined. It all boils down to prices.
Following Fed Chair Powell's FOMC meeting, U.S. bond yields have come in nicely. Is the Fed active in the back buying them? It remains to be seen. But as China slows down and commodity prices fall, the inflation narrative weakness helps support bonds here as well. This now becomes a headwind for oil which was previously a tailwind.
Oil is a seasonal commodity and there is a window of opportunity depending on which product is most in demand. We have just exited the cold winter northern hemisphere weather, and most of Europe has extended their lockdowns further, with the vaccine rollout delayed. This delays jet fuel demand even further. There is no shortage of oil, there never was. It was just a short period of time when China came in to restock, winter took hold together with OPEC+ jawboning the market. We can sill have periods of oil market strength, but we are in a secular demand decline. One just needs to see it as short bursts of strength in an otherwise overall falling market. It is no copper, there is no deficit or shortage of projects to be sanctioned, there is just the perception of it.
