The OPEC put, just like the Fed put, is nothing other than a fallacy, or perhaps wishful thinking at this point. After the Russian invasion of Ukraine, as Brent oil spiked to $130 a barrel plus, money rushed into the oil sector as we heard doom-and-gloom calls about a lack of energy capital spending, running out of spare capacity, and how oil prices would need to be higher for longer to spur that investment.
True as some of those calls may be, commodities don't work that way. They are driven by actual demand and supply at any given time and by the inventory balance. Of course, academics and analysts tend to move their models at extremes to price in the latest scenario. But trading does not care about research-driven models. After all, if we believed research-driven models, Tesla (TSLA) was supposed to trade at $1.500.
It is easy to tweak an Excel model to spit out whatever confirmation bias you may have, or play with the denominator to generate the result one wants to see. Assumptions are very important in any modeling, and that is where the problem lies. Most models get demand entirely wrong.
After the rout in technology stocks in 2022, most investors parked their money in what they deemed as safe haven assets, such as large-cap equites that showed 4%-5% yield on their balance sheets. But those very same dividend yields are subject to cash flows, and if the top line erodes, so do those cash flows. A stock needs to give an investor the right upside reward potential for the risk the investor takes to invest in that equity. But if US government bonds yielded the same coupon as a risky equity, one would be better suited to be invested in the former.
Just as we saw in natural gas markets when prices got to as high as 300 euros per megawatt hour and most called for Europe to be sent back to the dark ages, lo and behold, the physical market finds a way as there are entrepreneurs who will find a way to capitalize on these arbitrage opportunities. US liquefied natural gas (LNG) companies did just that as they profited from the massive $10/MMBtu vs. $2/MMBtu differential by sending all their cargoes to Europe as Europe was desperate.
European gas today is trading below 45 euros per MWh and politicians are still debating energy and gas security. The oil market is slightly different in that we have had OPEC and Russia working together to balance the market, supporting prices so to speak. This only works when the market is tight and you are the only swing producer, i.e. in 2021. But today, demand is not as strong despite China reopening its economy, and there is no need for additional barrels. When demand is weak and supply picks up, there is nothing much that can be done to support prices.
Oil equity investors held onto their long oil bets all throughout 2022 as they hoped for China's return or Russian barrels to come off the market. Neither has happened. Oil prices are down 50%-plus as analysts who assumed $90 a barrel was the floor for oil are seeing less than $75 a barrel now. One forgets that we were trading below $75 a barrel before Covid.
The same wishful thinking is heard in the equity market as most retail investors think Fed will come to their rescue as it did in the past decade and start quantitative easing (QE) again. But what the Fed and OPEC have in common is that they never had to deal with a harsh recession and higher inflation at the same time. Both have their hands tied for now, for if they were to either print more money (in the case of Fed) or cut back on supplies (OPEC), it could cause a price surge, but only in the short term, as that would collapse the global economy as we know it, sending it back even worse than the 1970s.
