Oil has fallen victim to the economic slowdown resulting from U.S./Sino trade wars that accelerated in May. Following a first-quarter stimulus injection and OPEC cuts of 1.2-1.5 million barrels per day put in place since December 2018, Brent oil rallied from $52/bbl to highs of $72.5/bbl in April. OPEC+ (OPEC plus Russia) were busy slapping each other on the backs, rejoicing in the doomsday scenario that was avoided.
Then, as Trump increased the rhetoric on China in an effort to coerce them into acquiescing to his terms or risk higher tariffs, the market reacted violently. To add further salt to the market's wounds, global economic data coming out in April and May was terrible, despite the record injection by the Chinese central bank and a dovish U.S. Fed. As Chinese and emerging markets took a massive hit in May, so too did their growth proxies like copper and oil, as both are a function of "economic growth."
This is a fact that is misunderstood by a lot of oil-trading hedge funds as they focus solely on physical market dynamics but ignore the broader macro winds that tend to distort the timing of the "real move." Oil is a function of both. There is no doubt physical market fundamentals always come into play, as commodities are all about demand/supply and how much of the product you have in deficit or excess. This is certainly the bane of OPEC's existence as they, too, cannot understand why the oil price fell viciously back in Q4 2018, but took all the credit for their cuts for the rally in Q1 2019. After all, if the cuts had been the primary reason why oil held up, then how come it fell back in May?
Going into the OPEC meeting to be held in Vienna on June 25, the market is nervous to see what OPEC will do. Prior to the May oil price correction, there was gossip amongst the ranks that OPEC (mostly Saudi Arabia) would start to raise production soon as "cuts had worked." Not to mention pressure from the U.S. and how they were holding up prices. Also, seasonally speaking, demand does pick up in the summer months due to cooling demand.
As the oil price fell 15%, those rumours have been squashed. Saudi Arabian Energy Minister Khalid Al-Falih commented at an economic forum in St. Petersburg that OPEC was close to making an agreement to extend the cuts past June. Whether non-OPEC (Russia) follows suit does not matter, as both parties seem very happy with the price here. If oil were to fall to below $55/bbl, that is a different story altogether.
Macro gossip aside, let's get back to fundamentals. We are entering the peak summer gasoline demand season, requiring more refineries to burn crude to produce gasoline to satiate that demand. This is going to be the most-important driver for oil over the next few months.
Week-on-week gasoline demand has held relatively stable, at around 9.3 mbpd, but distillate demand (usually representative of global economic growth) has been appalling, at around 3.4 mbpd. Meanwhile, U.S. production has been on a tear, printing at record highs around 12.5 mbpd. Both OPEC and the U.S. are benefitting from the production slowdown and tariffs in Venezuela and Iran. No wonder the market is conflicted, as demand is the unknown factor.
The jury is out for now on what will happen, as June brings a trifecta of macro events: the Fed FOMC meeting, OPEC meeting and the all-important G-20 meeting.
One thing is certain. U.S. shale producers are burning through copious amounts of cash despite higher oil prices, as capex overshadows proceeds. Over the past 10 years, the industry has burnt through $190 billion worth of cash. Shareholders are impatiently waiting for more capital discipline and higher cash returned back to them. If WTI trades down to $45/bbl, then that will cause some serious stress as U.S. shale will not be able to drill oil feasibly.
It seems the choking point is if Brent breaks below $60/bbl or WTI falls down to $45/bbl. Until then, oil will be whipsawed by U.S./China trade worries -- especially if economic growth is falling off a cliff. Time to be patient and see how events unfold before being forced in, despite seeing green on your screen for the past week.