A Wild Card In Oil Markets

This column needs to be somewhat of a hodgepodge of ideas, because the one consistent thesis that has moved our investment needle for the last year and a half - the supply shortage in crude that continues to emerge - hasn't shown any signs of weakening. But some other, trade associated ideas have come into the picture that we must be aware of, and use to fine tune our investment strategy.

These are three main ones:

First, there is the continuing threat of a trade war. While President Trump had once backed away from the plan of steel and aluminum tariffs when it was announced in March, since May he has again signaled wide-ranging metals tariffs to go into effect starting on July 7th. Since those signals in May, most traders, and in fact the markets at large, have been treating the tariff threat with sangfroid - assuming that again the President would have to retreat from a trade war with our Allies and China. And while the White House has backed down from additional threats of intellectual property penalties on Chinese electronics and tech, the plans for the metals tariffs still remain in place.

Understanding that the targets of these tariffs - both our allies and China - have indicated that they will strongly retaliate with tariffs of their own and, in the case of China, with perhaps other even more targeted measures, it is tough to see another way out of this dilemma than for Trump to at some point blink and step back from this frankly economically unhelpful path. Yet two banks - JP Morgan and Morgan Stanley - have released client notes this week warning investors to reduce exposure, now believing that President Trump may not, in fact, turn away. We've seen several grains and metals commodities begin to crater on the possibility of a trade war, and if it does begin, oil will not be far behind.

Second, there is the concurrent rise in the dollar - which has helped to pressure the livestock/grains/metals contracts lower. What has been interesting to us, of course, is that the big rally in the dollar has done nothing to slow the big rally in oil - this after years of being told that the dollar and oil were inexorably inversely correlated. Now, I have been one of the few voices who have maintained for years that the dollar's moves have impacted oil almost entirely because of the algorithmic trading programs that have set upon it - a sort of "build it and they will come" connection that had little to do with global oil barrels being priced in dollars. So - believing that I have been right all along, what we need to do is continue to track the speculative activity in oil to try and ascertain when the machines might again want to play this dollar/oil connection they've been currently ignoring (or short-circuiting). Spec longs have been decreasing, but shorts having really been increasing, and this is what I'm going to look for as a 'tell' of when the dollar will again impact oil and our oil stocks.

Finally, there is the massive collapse of the Brent/WTI spread back to nearly $4. Much of this has been blamed on the outage of the Syncrude facilities in Canada, and their 350,000 barrel a day shortfall. This is a big deal, of course, but the short-term spreads in WTI futures would indicate that the markets aren't expecting much more from this than a 2 month shortfall. But while the Syncrude slowdown looks to be a very temporary supply disruption, there are others in the US that are less so. Foremost is the Permian bottleneck, where even Scott Sheffield admits that Permian throughput will be completely spoken for by September, at which point trucks will need to be brought in (with their additional $10/barrel costs) if more crude from the Permian will be permitted to get to market. Several analysts (particularly at RBN) see this infrastructure shortage as lasting through most of 2019 and into 2020, so it puts the EIA estimates of production increases in the Permian in great doubt - the US will not reach 11m barrels this year as they predict, that's for sure. Add that to the 600,000 barrels a day that OPEC has approved to increase that will weigh on the Brent contract, and you've got both temporary, but also systemic reasons to believe that US oil is going to continue to be more constructive going forwards.

All of this informs a more cautious and more selective investment plan going forwards for the next couple of weeks, until at least the July 7th trade deadline passes and we see where this massive trade issue is headed. We can attempt to predict and plan for the others, but President Trump's decision on trade remains a wild card no one can be sure of.