Saudi Power Over Oil Prices Is Limited

Are you getting bored of the oil market yet? Traders are. Brent crude achieved just a $3.12 range in the ten trading days ended March 12th, representing its most narrow band since May of last year. While headlines have screamed about the impending bearish doom or bullish boom they happen to see ahead, the real story has been that oil markets have substantial buffers on both sides of the range. Option traders see the trend persisting in the near term with the straddle expiring April 25th worth just $5.00.

This week's key headlines have fit neatly with the sideways trend. On the supportive side, Monday's Saudi announcement of larger than expected exports cuts in April (which are still focused on the US) gave the market a bullish jolt. On the resistance side, the most recent IEA forecast predicting an additional 4m bpd of US supply growth over the next five years points to the limits of OPEC's ability to manage the market higher. We continue to adhere to the idea that OPEC+ can absolutely manage downside risk in the market but they'll have trouble creating genuine upside risk. For fun, we'll even define this numerically offering that OPEC+ can keep prices above $50, but they can't push prices over $75 without a parallel bullish narrative.

So where will oil's next big move come from? For upside, we're still believers in the idea that OPEC production cuts, dovish central bankers and a US/China trade deal will serve as potent bullish factors. There seems to be a bit of extra juice in the OPEC component of the bullish triumvirate for now as exports from Iran, Venezuela and Nigeria look particularly tenuous. Unfortunately for bulls, these themes are almost entirely priced into markets now and there will have to be some substantial data surprises for one of them to generate another leg higher for prices. Perhaps some extremely sharp US inventory draws could do the trick.

On the downside, global trade woes, weak refiner demand and growing US supplies will continue to keep a lid on prices. This week's IEA forecast on US crude supplies topping 13.5m bpd by 2024 was alarming and will certainly mitigate upside risk for prices if it comes to fruition. On the economic side, LNG flows have revealed some of the stress that US/China tariffs are putting on economic activity as only one China-bound US tanker has been delivered in 2019 after averaging about 2.5 per month in 2017 and 2018. On Tuesday US trade representative Robert Lighthizer suggested a US/China trade pact will be reached in the coming weeks in comments to the Senate Finance Committee. Unfortunately, our concern persists that a deal may not do much to boost confidence in a market where US refiner demand growth has been nonexistent over the last six months.

Looking ahead, we think oil looks fairly valued in the mid/high $60s with OPEC+ providing support while soggy demand weighs on the strength of rallies. Saudi Arabia could very well announce sub 10m bpd production and sub 7m bpd exports in the coming months. If/when that occurs, there will likely be a knee jerk reaction from traders to push things higher. Don't get too excited- there's simply too much negativity in the market to push above $75.

Quick Hits

- Global crude prices were slightly higher to begin the week with help from the Saudi announcement that deeper cuts are on the way this spring. Brent crude traded near $67 while WTI traded near $57.

- Saudi Arabia's announcement was sharpened by unconfirmed reports that OPEC+ could be looking to extend their cuts into the second half of 2019. In our view a cut extension seems entirely plausible as cooperation with the effort has been strong.

- Massive power outages worsened production issues in Venezuela this week. While we aren't sure exactly where the country's output is at the moment, rallies in prompt brent spreads corroborate the idea that global crude markets are tightening. This week the prompt 6-month brent spread moved from +44 cents to +74 cents.

- The Paris-based IEA made the week's largest bearish splash predicting substantial growth in US production through 2024. In the US, however, the Department of Energy trimmed its US output forecast for 2019 from 12.4m bpd to 12.3m bpd. US production is currently running near 12.1m bpd.

- Demand concerns are in sharp focus for oil these days and DOE data has failed to show any gains in US demand so far this year. Refining margins are currently trading at historically moderate and/or slightly higher levels which could help jump start things this summer. This week the WTI 321 crack was steady near $21/bbl with the gasoline / WTI crack near $19/bbl while the heating oil / WTI crack traded near $26/bbl. Overseas, the gasoil/brent crack traded near $15/bbl.

- Refined products continue to strengthen in the US with domestic gasoline prices moving over $1.80/gl for the first time since November.

- Hedge funds were net sellers of ICE Brent derivatives last week for the first time since December. Overall net length was cut by 3k contracts moving from 291k to 288k. Meanwhile funds were net buyers if NYMEX WTI futures and options bring net length up 20k contracts w/w to 152k.

- Bank analysts were mixed on crude oil forecasts this week but mostly saw crude oil moving sideways in the near term. UBS cut their 2019 Brent crude forecast from $68.50 to $65.75 while Morgan Stanley cut their 2Q Brent forecast from $62.50 to $62.00.

Quick Hits - Macro Focus

- From an oil market perspective the macro climate was mixed this week. Stock markets were broadly higher led by Asian shares and bond yields were lower on weak economic data and another Brexit fiasco. The US Dollar continued to trend higher which weighed on commodity prices.

- 'Bond King' Jeffrey Gundlach gave harsh remarks on the state of the US economy this week saying S&Ps will sink in 2019 and even take out their 2018-lows. The fund manager was highly critical of rising public and private debt levels, partly blaming President Trump. The investor also took time to criticize Modern Monetary Theory which is gaining traction in liberal economic/political circles.

- S&Ps traded near 2,800 mid week representing a 22% increase since their low print in December. The index is 5% below its all time high in September.

- Overseas, the Shanghai Composite continued to scream higher as the People's Bank of China took additional measures to prop up the economy and the Trump/Xi leadership teams appeared to move closer to signing a trade deal.

- Bond prices rallied sharply this week driven by a disastrous vote for Theresa May's Brexit deal and weaker than expected US CPI data. The US 10yr yield fell to 2.60% for the first time in two months and the yield curve flattened as well. Core CPI in the US rose 0.1% m/m and 2.1% y/y.

- For metals, copper prices were basically flat this week near 290 holding on to an 11% rally YTD. Gold prices retraced some of their recent losses moving higher towards 1,300.

- The US dollar index has continued to levitate and reached its highest mark since 2017 on Friday at 97.7. This is bad news for crude oil bulls who continue to suffer from currency stress despite continued dovish signaling from the US Fed.