Brent Oil is up 60% since the November lows of $36.25/bbl., it has gone up in a straight line just as the first headlines of a vaccine with greater than 90% efficacy were released. With hopes of the life going back to normal and countries reopening allowing travel once again, oil which had been one of the hardest hit commodities from the pandemic, has been rising ever since. Lockdowns meant less travel, which meant less jet fuel demand. This is why we built about 1.2 billion barrels of oil inventories back in April 2020 when the world ground to a halt. Today oil inventories are at an excess of 505 million barrels, significantly down from the highs thanks to OPEC+ members taking about 8-10 mbpd of oil out of the market to support prices. But as prices nudge towards $60/bbl. Brent today, where do things stand?
The weakness back in April 2020 was exacerbated by the oil price war between Russia and Saudi Arabia when at the time the pandemic was just starting and its true extent was not known yet. Price back then was around $50/bbl. and Russia was not playing ball with Saudi Arabia to promote yet another cut. It is important to note the price level Russia is happy to keep producing oil to maximize revenues of $50-$55/bbl. We are there now and more. OPEC+ alliance is hanging by a small piece of thread, as each day the prices nudge higher, more and more members will be screaming to the committee to want to produce more. Right now, Saudi Arabia is appeasing its most important member, Russia, by letting them go ahead and produce, but taking the pain and giving up market share. They decided to take 1mln bpd more out of the market in February and March, which typically is winter season period that sees a pick-up in distillate demand. In a nut shell, they tightened the market artificially but are losing out on oil revenues. What is their plan? The world gets vaccinated asap and opens up so that oil demand recovers back to pre-Covid levels in time for them to sell all their withheld oil at much higher prices. This can work really well, but if prices get high enough, more and more producers will want to pump more. And if oil demand is not able to normalize till perhaps 2H21 or 2022 even, then the Saudis would be seen waiting before it even reaches their target.
There is huge debate about how much U.S. shale oil can come back given the permanent hit to their infrastructure back in April 2020. From highs of 13mbpd of production, U.S. oil production is around 10.9 mbpd. The industry has learnt from past mistakes of overproducing, but let's not mistake, the memory of this market is like a gold fish. We know they perennially overspend and overproduce trying to max out their revenues. The credit markets are always open to them and even though they have made promises to be more "disciplined", we know that every day the prices go higher, the bankers are enticed to help.
Currently, U.S. rig count has started responding to the rise in prices. Albeit from a low base, we have seen an increase in exploration expenditure and drilling programs. Rigs have gone up by 123 (72%) in little over five months, according to Baker Hughes. It is still down by 380 compared with same period last year, but it is trending higher. We know that there is an average 4-6 month's time lag before the oil shows up from when the rig count picks up. Prices started rising back in November, so we should start to see more U.S. oil sometime around April to June this year. It is a function of oil price. The longer it stays here, the more likely it is.
Saudi Arabia better wish that the debt markets are close to the U.S. companies. But we know from experience the U.S. producers are entrepreneurial and shrewd. Perhaps Saudi Arabia should be happy with prices closer to $60/bbl. as it may not get a chance to sell later. We all know the oil market is only holding up because OPEC+ has kept 8.7 mbpd of oil out of the market. But how long do you think this alliance lasts when each government that is a part of it sits there glaring at their individual budget deficits as the potential value of their exports keeps nudging higher?
