Russia and Saudi Arabia made waves in the oil market this week and not for the reasons we expected. The two parties- who were scheduled to meet in April to discuss prolonging their current supply cut agreement- decided to postpone their special gathering and wait until OPEC’s previously scheduled meeting in June to decide the future of their deal.
The move was widely interpreted as revealing a fissure in the Saudi/Russia relationship which is the heart of the current OPEC+ deal. Concern that the existing deal could eventually break down is built on the reality that the two countries have entirely different budgetary needs for oil prices to keep their houses in order. According to Bloomberg, Russia needs $40 oil to meet to run a balanced budget this year while the Saudis need $95/bbl. Over time, differing needs could strain the relationship and lead to the end of the current OPEC+ agreement. We don’t view this as a high risk in 2019, however, and ultimately expect the group to continue sharp supply cuts through the end of the year
We know that OPEC+ production cuts achieved 89% compliance in February displaying strong group discipline. These cuts will continue to eat into global inventories and reveal themselves in weekly DOE data which shows US stocks drawing despite massive gains in US production. Planned supply cuts and lost barrels due to geopolitical stress in Iran, Venezuela and Nigeria will shift price risk slightly higher in the near term. For evidence of the current geopolitical strain, look no further than Venezuela which reported crude production of 1.4m bpd in February while a Bloomberg survey of analysts pegged the nation’s output at just 1.0m bpd. It’s very much worth noting the prompt Brent 6-month time spread reached a new YTD high this week at +1.04 suggesting traders see increasingly tight balances heading into the summer.
The other key meeting for markets this week is the US Fed gathering which will be followed by important signaling on the future path of US rates. Analysts broadly expect to see one rate hike from the central bank in 2019 and 1 or 0 hikes in 2020. Given the recently moderate path of US economic data and healthy performance of equities we expect the Fed to take a neutral tone and avoid giving traders significant bullish or bearish ammunition. This week the US 2yr bond traded near 2.45% which is lower by bout 10 basis points on the month and slightly higher on the year.
In the White House, President Trump is back to Twitter bemoaning high oil prices and asking his friends in Saudi Arabia to pump more crude. We remain skeptical that Trump will be able to persuade the Saudis to abandon their deal in 2019 after hoodwinking them into adding barrels in 2018 only to grant waivers to Iran’s largest customers. We still think the most likely outcome for Trump/Saudi relations The President will undoubtedly have a say in creating a US/China trade deal, however, and we’re seeing both sides push towards a late-April summit at Mar-a-Lago to get a deal done.
Sorry to end things on a negative note, but we still see a large risk that markets are underwhelmed by a US/China trade deal after its signed. Even if the two sides completely abandon tariffs investors will still be left with a slow-growth global economy and incredible political disfunction in much of the Western world. As the old saying goes, ‘buy the rumor, sell the news.’ Oil traders have been buying a lot of rumors so far in 2019.
- Oil prices hit a new YTD high this week with Brent printing $68.20 while WTI reached $59.57.
- Crude spreads also jumped to new heights this week with Brent’s prompt 6-month spread trading +1.04 while WTI’s 6-month spread traded -0.45. The difference between the two spreads highlights the comparatively dull forecast for US fundamentals due to the onslaught of domestic production. Meanwhile OPEC+ cuts and strife in Venezuela are expected to keep Brent fundamentals relatively tight.
- OPEC+ decided to cancel their plans to meet in April as the group decided it was premature to decide whether their current supply cut strategy. Russian Energy Minister Alexander Novak commented that prices are trading in an acceptable range.
- Two banks authored bullish notes this week. Citi commented that an extension of OPEC+ cuts through 2H19 could push Brent over $90/bbl. Goldman sees global oil demand growth of 2m bpd in 2019- well above most forecasts- and believes Brent will rise north of $75 in the near term.
- +$75 oil would undoubtedly draw Tweets from the US President. While we don’t think the White House will be able to convince the Saudis to pump more oil in 2019, we do think the US could grant more waivers to Iranian crude buyers in May to counteract higher prices.
- Vitol – the world’s largest independent oil trader- sees oil demand peaking in the next 15 years.
- Oil options markets continue to lean bearish and suggesting the producer hedging is outweighing any bullish speculation in the market. This week 50 delta WTI options implied 27% volatility. 25 delta put options priced at 31% while 25 delta called options priced at 25%.
- Newswires reported there was pushback from China this week on recent trade demands. Global equities mostly held on to recent gains suggesting markets remain optimistic about a deal getting done. China’s Shanghai Composite is up by about 21% in 2019.
- Interest rates continued to plod along at low levels this week suggesting continued confidence from bond traders that central banks will stay dovish. The US 10yr traded near 2.61% mid-week. Low rates are also a reminder that global growth forecasts remain low and demand concerns are substantial.
DOE Wrap Up
- Last week’s DOE report was more bullish than bearish and included solid overall stock draws for crude oil and gasoline. US crude supplies also made a small w/w decline which gave traders some extra permission to buy.
- Unfortunately, refiner demand and gasoline demand + exports remain stubbornly low and have actually contracted y/y over the last four-week period.
- US crude inventories fell 3.9m bbls last week to 449m and are 6% higher y/y over the last month.
- Inventories in the Cushing hub also fell moving from 47.5m bpd to 46.9m bpd.
- The US currently has 28.2 days of crude oil supply on hand which is higher y/y by about 5%.
- Low imports persisted as the key source of bullish US fundamentals. Traders imported 6.75m bpd last week which is more than 1m bpd less than their 2018 average.
- Traders exports 2.55m bpd of crude last week and have averaged exports of 1.95m bpd over the last twelve months.
- Refiner demand moved slightly higher improving from 15.99m bpd to 16.02m bpd. Demand is lower by 100k bpd y/y or about 0.6%
- US gasoline stocks fell sharply from 251m bbls to 246m bbls. Inventories are still higher y/y by about 1% despite the drop.
- Distillate inventories increased by about 400k bbls to 136m and are flat y/y.
- US gasoline demand + exports printed 10.1m bpd last week and is averaging 9.75m bpd in 2019 which is lower y/y by about 50k bpd. Demand is lower by 80k bpd over the last month.