Following the summer, as Brent reached new highs of $86/bbl. in October, every sell-side analyst came out predicting oil in the $100 to $120/bbl. range. They cited shortage of inventories, rebound in travel demand, lack of OPEC+ supply and strong winter demand caused by gas to oil switching, to name a few. All these reasons of course, hoped for the most bullish of factors working together at the same time, and if so, oil could most certainly get there.
But those predictions were dependent upon a lot of "ifs" without pricing in any margin of error. Low and behold as we exited the summer driving season where demand enters a brief period of lull, a few weeks later, oil prices fell 20%+ down to lows of $66/bbl. even. Omicron was the trigger that lit the fire, but once again, the market had not priced in any risks whatsoever. Now most sell-side analysts would like to call this a "margin of error" in their estimates, but that sort of performance over a few weeks could make or break the year for most hedge funds. So, does it matter? It absolutely does!
We have repeated this statement ad nausea all throughout 2021: There has never been any shortage of oil, its direction has all been about timing the seasonal demand with the demand/supply balance at stake. This year the oil market had an extremely strong tailwind, OPEC+ group, which has been extremely cautious in releasing back all the oil production it took out of the market last year post the pandemic related slowdown. One must ask why? They have learned from the lessons of the past and realize their countries' real fortunes still lie in the price of oil that dictates its future budget spending plans and the economic health of the region.
There was a small window of opportunity whereby they knew they were in the driver's seat to "support" oil prices and so releasing it in dribs of drabs of 400k bpd a month, months after the recovery had taken full force, left the oil market tight in a very short period of time. One can argue how much of the demand surge was due to real underlying demand and how much due to the aggregate demand generated by overall Fed stimulus on steroids. OPEC+ key defense is using the Covid related demand slowdown as their excuse to refrain from pumping more. True as that may be, it is in complete odds with the rest of the other academic institutions.
One of the biggest problems arising in any of these projections is the demand numbers assumed that even a slight tweak can cause a market shortfall in a short period of time. Therein lies the real dilemma. What is demand going forward? Three out of five of the initial bullish factors stated by the sell-side still hold to be true, and as we enter the winter period of the northern hemisphere, those facts are still valid, just as oil prices got a good $20/bbl. cheaper. The risk reward looks a lot more favorable now it seems. U.S. shale production has picked up to 10.7 moped and it could slowly move higher. But the fact of the matter is that if winter is deemed to be cold, as we saw last year, the market can surely get tight in a very short period of time as OPEC will not be back at full production till March, and that may be too late.
One of the factors that has certainly not been removed from these assumptions is a lack of travel related demand. Due to the latest Omicron scare, worldwide cases are soaring and travel is being pushed back, hence the recovery is pushed further out too. What will China do after deleveraging all of 2021? Now that Fed is faced with much higher inflation year over year of 6%, they are aggressively reducing their liquidity, but net they are still adding to their balance sheet. What happens the next time around when we see much higher year over year prints in inflation? Will the Fed be forced to finally raise rates? All this matters for oil and more.
As we said, it is all a timing game, to play the long or the short side of it. For now, let's focus on those weather charts and see how much cold weather is due for the northern hemisphere. Perhaps those sell-side analysts may prove to be right after all, by luck. But then again, as they say, better to be lucky than smart.
