On November 30th two rather powerful men are set to have a meeting in Argentina and they may very well decide the short-term fate of global oil prices.
Markets have been holding their breath in the lead up to the Trump/Xi meeting at the upcoming G20 summit, and this week they seem to be running out of air. Crude oil tumbled and US stocks tanked as the two sides squabbled over current trade arrangements which ultimately ended up in a US-bound China trade delegation cancelling their trip. US Vice President Mike Pence reiterated that the US will not hesitate to double current tariff levels on roughly $250 billion worth of goods and Trump rejected a list of 142 concessions made by Chinese officials as inadequate. The US Trade Representative’s office also released a report on Tuesday concluding China has yet to begin altering the practices which the US views as unfair. Both sides seem to be downplaying the likelihood of reaching a deal prior to January 1 when the next round of US duties will increase to 25% on a wide array of Chinese consumer goods.
From our angle, it appears that Trump and Xi seem to be the only two people who could slow the radically bearish price action in oil. Brent crude has tumbled from $86.74 to $61.71 over the last six weeks as massive over production from Saudi Arabia has been exacerbated by increased confidence that the global economy is heading into a chilly 2019. Global markets are increasingly playing defense, as evidenced by this week’s flight out of US stocks and into short term US government bonds. Speculators continue to drive much of the price weakness in crude having cut net length held in WTI and Brent to its lowest level in more than two years while more than tripling their new short positions since September.
This week the geopolitical front was mixed as it related to an OPEC+ crude deal. On the bearish side, Russia seems to be dragging their feet in joining a potential supply cut deal. So far, Russian Energy Minister Novak has merely commented that they need to further assess the state of the market before agreeing to cut supplies. On the positive side, Saudi Arabia may be emboldened to lead a round of production cuts after President Trump fully aligned himself with MBS despite a CIA report concluding that the murder of Jamal Kashoggi was led by the crown prince. Reaching a deal will be complicated by the fact that the Saudis need a substantially higher Brent price (roughly $75/bbl) to operate with a balanced budget than the Russians (roughly $55/bbl) do after Putin realigned Russian spending during the 2015-2016 bear market. Nevertheless, we still expect to see reduced supplies from OPEC+ beginning early in 2019 in order to prevent another tsunami of hedge fund selling.
In the meantime, trade concerns are dominating markets and we don’t expect to see any positive signs from either the Trump or Xi camps prior to formal negotiations at the G20. These concerns will only be compounded by the impending US Fed rate hike which will keep upward pressure on the US Dollar and push commodities lower. Nevertheless, the majority of research we see still views oil as oversold and sees a rally to +$70 for Brent into the end of the year. There very well may be some rally potential in the coming weeks as hedge funds inevitably cover the short positions they’ve built over the last two months, but it will certainly take a strong stomach to buy the current dip in oil!
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- Oil prices are under a bearish assault yet again this week with WTI lowering to $53 while Brent touched $62. WTI’s selloff now represents a 13-month low while Brent is on an 11-month low. Both grades are down more than $22 over the last six weeks.
- The primary driver of crude bearishness has been continued global trade pessimism related to China and the US. Rhetoric from both sides suggests that they remain far apart in their efforts to forge trade pacts and markets are increasingly concerned that this is not just jockeying for a better bargaining position prior to the impending G20 meeting.
- Hedge funds were confirmed as contributors to last week’s price bearishness by this week’s COT report. Speculators cut more than 10% of their combined NYMEX WTI + ICE Brent net length last week and more than 22% over the last two weeks. Gross short positions have more than quadrupled in NYMEX WTI over the last two months and more than tripled in ICE Brent.
- Adding to the macro concerns is that markets still expect the Fed to hike rates again in December. The US 2yr bond yield was near 2.80% this week as investors rushed to safety and out of stocks and commodities. If we zoom out a bit, however, we’re reminded that the 2yr yield has increased by more than 50% in the last twelve months and that financial conditions are obviously tightening as a result. The US housing market continues to show signs of slowing with cooling prices and mortgage applications.
- US stocks struggled mightily to begin the week lead by a bludgeoning of tech stocks. The S&P 500 traded near 2,640 mid-week and is lower on the year by about 50 points.
- On a more positive note, the Shanghai Composite seems to be expressing a more positive view of trade related comments made by US and Chinese leadership and has rebounded by more than 5% in the last four weeks.
- Another positive note: US gasoline spreads (previously a predictor of the oil market’s woes) have rebounded in the last two weeks. The US gasoline 1-month / 6-month spread has jumped by about 4 cents as funds and trade groups have speculated that the market could be due for a short term bounce.