If one were to look back one year when WTI oil prices traded at -$40/bbl., one would never have imagined to see WTI trading closer to $65/bbl. today, back above the level before the March Covid crisis. This is what happens when a market that is controlled by three nations, Saudi Arabia, Russia and the U.S., one of which does not rule logically but emotionally constantly surprising the market, more often than not in the wrong direction, which they only realize much later when the damage is done. Last year as travel demand was getting hit, Russia did not play ball with Saudi Arabia for the cuts, to which the latter decided to "teach them a lesson" and flooded the market with extra oil at a time when world was going into lockdown. Not realizing the power of their own actions, they caused oil prices to go to negative as there was just not enough storage space to store the oil in one contract month expiry.
Fast forward one year, and oil prices are up 75% since last November when they managed to get OPEC+ to keep an extra 2mbpd of oil out of the market, and the world was not even fully opened yet! OPEC+ was gradually releasing oil in the first three months of the year by 500k bpd, and April would also see the normal 500k bpd increase. That was supposed to be a given. Saudi was supposed to add back the voluntary cut of 1mbpd, but instead they held back the entire 1.5 mbpd and shocked the market! They released more in the earlier part of the year when prices were lower, and now holding back just when they got the highs. Once again, squeezing the market one way!
Currently the global oil market demand is still about 5-6 mbpd shy of pre-covid levels, as this is expected to return when the world gets vaccinated and returns to normal, mostly travel and jet fuel demand. One other thing that is benefitting the oil price is the massive macro rotation of decades of long money that has been underweight Energy vs. Long Technology, finally unwinding this trade give the inflation prospects going forward. Central banks have printed close to $20 trillion+ with the U.S. balance sheet up by $4 trillion last year and another $2 trillion fiscal stimulus to come yet. This macro tailwind has boosted US 10 year bond yields to north of 1.5% from lows of 0.5%, as inflation is certainly evident, despite Powell's constant denial. It is evident in all food, energy, grain and producer prices as seen by Prices Paid Index and companies passing higher costs to their consumers. This inflation backdrop supports more money coming into commodities as this rally becomes self-fulfilling. The macro flows always exaggerate the true physical fundamental level of the oil market as investors are looking for yield and the oil market now with its backwardation is giving that to them.
If OPEC+ were to let oil flow as a free market commodity, then prices would surely be lower and stable. Russia produces and cuts logically based on their cost of production so with prices above $55/bbl. Brent, they refuse to not produce what they can. U.S. shale has been severely wounded since last year's collapse, the marginal price setter is Saudi Arabia and they are using this to their maximum. Their country knows that this is probably the last cycle of oil and their need to diversify into other areas and pay their budget deficit bill that needs oil prices above $85-90/bbl. The only question is how soon can U.S. shale return - it is all about pricing economics. The market has a short-term memory, and if prices keep going higher, banks will lend them money to produce more. It is just a matter of time. The U.S. rig count has been picking up since last November, there is a six-month's time lag when barrels hit. So, Saudi Arabia is lucky to be able to squeeze the market now and monetize as much as they can. There is no shortage of oil, it is just being held back, and the only question is when it hits.
For now, they have achieved their objective, showing President Biden firmly who is in charge. U.S. consumers face gas prices closer to $4 at the pump in some regions, which in addition to another inflationary pressures and lacking job growth, is going to kill the economic recovery altogether. If inflation was ever in doubt before, make no mistake, with this latest OPEC+ move, inflation is almost guaranteed. It is better to release oil slowly and consistently so that demand grows consistently over time. But it seems one main producer is too greedy to squeeze it as hard as fast, but that will only choke off demand and collapse the price once these barrels return. Short term gain over long term pain. History repeats itself in the oil market, but for now enjoy the squeeze!
