Brent oil prices have rallied a good $15 per barrel from the lows in July. The highs reached last week around $87 per barrel. It seems the OPEC+ council cannot withstand prices below $70, and hence decided to intervene, activating the OPEC put. Of course, the OPEC put, which is really the Saudi put, has no regard for the consequences of higher-for-longer oil prices -- as long as it maximizes its chances of receiving higher revenues for their oil production. Now, the Fed has to be quite mindful of activating the "Fed put," as the wrong timing can cause much dire consequences. As much as Saudi Arabia may sugar coat the cut as providing stability for the market, it is trying to protect a floor so to speak. But what they fail to realize is how their actions influence the entire world and the Fed put, as well.
During the summer, Saudi Arabia has a higher power burn, so it suits them to cut production now and pump more domestically. But it has extended its one-million-barrel-per day cut through the end of September, with the goal, or hope rather, that when Chinese demand returns, the world will be tighter than normal, causing prices to rally abnormally.
They are buying time hoping the eventual rebound in the fourth quarter will take over the job for them. But something more sinister is at work, and perhaps that's why OPEC should look past what economists tell them as they never get the cycle right in the first place. They may have succeeded in temporarily getting oil prices much higher, but the rest of the world is going through a very harsh slowdown that is yet to be felt in asset prices. China is imploding as it has a battle to either quell the disinflationary momentum or support the yuan. The currency is now trading at the lowest since 2015 vs. the dollar, but they are limited as to what it can do as its only hope is to boost the domestic consumer who is not willing to buy another home or another car. Latest Chinese data shows exports slowing down, which it needs to keep its debt fuel bubble going. Its property developers are defaulting on loans that are being offset by shadow banks; this entire Ponzi scheme is finally coming to light as it does not work if the second-hand home market is not on a constant uptrend. They tried to pump money in the economy in the first half of the year, that rally and growth fizzled out. China is not operating in a silo as it needs western world and their demand to chase their products.
The Fed has been fighting this battle to get inflation down, a mandate it will not give up on. But the longer oil prices stay higher, it defeats their purpose. This also means that it cannot cut rates when the time comes as inflation will be out of the box again, and then it will be too late. Saudi Arabia may think it is being extremely clever in tweaking the market to keep it up higher for longer, but this is making matters worse. They have cut their Arab light production, which tends to influence many refiners decision as to how much gas oil to produce. The lower gas oil production is causing havoc in the physical markets as gasoline refining margins are sky rocketing. A lot of refineries need light oil to produce products and not heavy oil. So, Saudis are playing a very cheeky game.
The problem is demand, not supply. And as much as one would like to keep prices propped up, if the demand rebound never comes, that price rally is futile. A recession will take all prices lower, despite the Saudi put. As each day goes by, the illusion of the Chinese and global demand recovery remains elusive, as the global economy is pushed into a harsh slowdown. OPEC may just be delaying the inevitable, but eventually commodities succumb to the global pressures, especially when the natural floor is nowhere to be seen around these levels.
