OPEC Won't Let On, but Oil's Price Scares the Cartel

It seems President Trump's daily voluntary spasms of angry tweets against China have done nothing but give away the cards in his hands. President Xi Jinping seems to have a much better poker face than his worthy adversary. Trump just cannot seem to contain his emotions or his decisions. He seems to lash out at one nation hoping to fear-monger them over the next few weeks. But when the other side calls his bluff, he tends to slowly walk back his threats. This has been the case all of 2019, but especially so in August when Trump decided to initiate 10% tariffs on the remaining $300 billion of Chinese goods starting Sept. 1. His hope was that China would come kneeling to his doorstep begging for a deal. Odds have it, it is the reverse. China is sitting there patiently watching Trump make a mockery of himself and his administration as his deadline to appease his voter base gets closer. Trump cannot afford a market collapse nor can he afford a weak deal with China; he seems to have check-mated himself. As equity markets have roller-coastered up and down the last two weeks, they took other asset classes for a wild ride, too. With the prospects of the global economy weakening further and U.S. recession fears rising, oil prices also got hit. They have fallen 12% in August so far, trading close to the key $55-a-barrel Brent level. As the market was close to breaching that level last week, we saw headlines from OPEC emerge suggesting it is considering all options to support oil's price. Reading between the lines, it suggests OPEC is scared and has no idea how much oil prices can fall, but these prices are not acceptable to the organization. OPEC looks purely at demand and supply of the physical oil market and forecasts where price can go. An occupational hazard of most academics and forecasters is to look at past demand trends and extrapolate similar growth to predict the balance of the market. They, like most sell-side houses these days, tend to adjust their numbers after a collapse or a spike has taken place. One wonders why we bother printing pages of research from these institutions. As traders and hedge fund managers, our job is to predict what that demand is likely to be based on a certain set of macro and micro indicators. Whether the physical market traders like it or not, oil is not an isolated asset class. It is vulnerable to exogenous shocks to the system and both need to be understood to carefully understand what the fair value of oil is. Perhaps OPEC needs to hire some hedge fund macro traders to assist it in its forecasts. But then again, who can hedge what Trump decides to do the next day? We know the state of the U.S. shale market goes into negative economies of scale when West Texas Intermediate (WTI) prices fall below $45 to $50 a barrel. Russia and Saudi Arabia form the OPEC+ group, where Russia is happy producing what it is as long as prices are above $55 a barrel Brent. On the other hand, Saudi Arabia is extremely nervous at these levels and would prefer prices to stay closer to $70 a barrel Brent. Its cost of oil is very low, but its vast spending plans and budget deficits require breakeven oil prices closer to $90 a barrel Brent. This is a contentious topic as politically Saudi Arabia is not able to admit nor suggest this. The truth is, the Saudis prefer higher oil prices. No matter how much and how fast they try to diversify their government revenues, the Saudis are still highly dependent on oil revenues. The infamous Aramco initial public offering (IPO) that once again is back in focus is also a big priority, but the valuation is of heated debate. What the government wants and what the brokers and investors are willing to pay for it are two different matters. One thing is certain: Aramco will need to show more visibility and transparency to get the global energy community on board as it covers all the large-caps, from Exxon Mobil and Chevron to Royal Dutch Shell , BP and the like. Taking a step back from macroeconomic issues, let's look at the fundamental oil market over the past few weeks. Everyone seems to be obsessed with tariffs, but what really drives the oil market over the summer months is gasoline demand as we are in the peak summer driving season. Despite oil price falling over the past few months, the shape of the curve is still in backwardation (where the price of front-month futures is higher than the price of the further-out contracts). A backwardated market implies a tight market, which tends to be positive for price. Gasoline demand has remained strong this summer and has picked up over the last few weeks, printing at 9.9 million barrels per day, above the average demand level for 2011-2018. Refineries need oil to process gasoline, so demand for now is holding up and should support prices at least until the end of the summer driving season in September. The Federal Reserve's Jackson Hole economic policy symposium is this Thursday, where Fed Chairman Jerome Powell will have a chance to address the market after the recent $16 trillion of global bond liquidity moving into negative territory and economic data printing even weaker numbers globally, but much better relatively in the U.S. The market is pricing in aggressive rate cut of 50 basis points in September, so any deviation from the Fed from such a move could cause a wobble in the bond and equity markets. On top of that, Trump is holding a call with President Xi. It seems he is ready to talk, but China will not give in that easily. #fakedeal There are a lot of moving variables for September. For now, equities seem oversold, bonds overbought, Trump willing to walk back on his angry tariffs, and a Fed potentially ready to throw in the towel and bearishness at extremes. Markets can grind higher from here if the 2900 level is taken back as key 200-day moving averages for both the S&P 500 and Nasdaq have held for now; is the path of least resistance up in the very near term?

OPEC Won't Let On, but Oil's Price Scares the Cartel

OPEC has no idea how much oil prices can fall, but current prices are not acceptable to the organization.

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