Commodity Trade Mantra

Citi Slams Historic Oil Price Surge: “Another False Start, Time To Fade The Rally”

Citi Slams Historic Oil Price Surge: "Another False Start, Time To Fade The Rally"

Citi Slams Historic Oil Price Surge: “Another False Start, Time To Fade The Rally”

Earlier today we were wondering how long it would take the big banks – many of whom are short the commodity – to jump in the path of the oil momentum train, and we didn’t have long to wait for the answer.

Just before the NYMEX close, Bank of America revised its year end and 2016 oil forecasts lower, from $58 and $62 to $55 for 2015 and $61 for 2016. But the real downgrade came moments ago from Citi’s Ed Morse who, together with Goldman, has been bearish on oil for a good part of the past year, just slammed today’s crude breakout and doubled down on his double-dead cat skepticism, when he released a report titled “Another False Start…Time to Fade the Rally” whose punchline is that “Citi foresees that WTI and Brent prices should post another fresh leg lower—perhaps making new 2015 lows—before year-end.”

More from Morse:

The Oil Price Surge

Another False Start…Time to Fade the Rally

The bullish c20-25% crude oil price spike since late last week looks driven more by sentiment than by reality.

Bottom Line: Citi foresees that WTI and Brent prices should post another fresh leg lower—perhaps making new 2015 lows—before year-end.

In Citi’s view, it’s time to “sell the news and buy the facts.” This is reinforced by today’s strong intra-day gains around 8%, which appear driven by a misread of market data and financial headlines.

Notably, nearby timespreads are lagging the move higher in flat price, which is consistent with weak fundamentals.

Sharp gains over the past three trading sessions were driven by a combination of short covering and chart-readers again looking to call a bottom falsely.

As recently as last Wednesday, both WTI and Brent were hovering at YTD lows of $38/bbl and $42/bbl, respectively. Combined futures and options net length held by money managers on NYMEX and ICE was also near record lows of 225-k contracts, matching the nadir in category positioning in 4Q’14.

The continuation of the rally was further buttressed today by (1) EIA reports showing US production was overstated; (2) non-agency reports that Saudi production had fallen by c60-k b/d m/m; (3) news chatter (CNBC, Reuters, Bloomberg, etc.) that highlighted the most recent OPEC Bulletin which, with no independent reporting, stated the producer group was willing to talk to non-OPEC producers to get ‘fair prices.’ In our judgment, this was a gross misrepresentation of the Bulletin’s editorial which was wistful about such a dialogue.

Almost all OPEC officials are still on holiday and the lack of further reporting suggests none actually were involved in suggesting there was a change in policy.

  • The EIA data should be treated with caution. The old EIA data were a fiction coming out of modeling; the new EIA data are coming out of sampling techniques that are untested and difficult to call reliable. Given the structurally unique nature of the US shale industry, whereby separating the durability of good and bad wells needs the test of time, further complicates matters.
  • 60-k b/d of Saudi production on a 10.3-10.5-m b/d base is a rounding error. Furthermore, there is no credible sign as yet of any change in Saudi market share policy, which is why Citi noted pre-open today that Saudi OSPs (official sale prices) would be of particular importance to monitor this month.
  • It is unclear as to why any non-OPEC producer would want to commit to a target with OPEC. 2015 is not like 1998 when both Mexican and Russian production were surging and when both countries participated in a supply cut. Russian production is growing this year because of a significantly weaker ruble cost of oil while Mexico is trying to push through energy reform. Neither country is in a position to really commit to a production cut, in our view.

Neither would the US, Canada or Brazil – the three main non-OPEC parties – willingly participate or agree to curtailing output, in our view; nor would they constitutionally be able to do so.

A (global) production cut today would mostly benefit US producers who can react quickly to price changes. The rig count increase in 3Q’15 following the (temporary) oil price rebound in 2Q’15 seems indicative of the resiliency of the US shale industry. For OPEC and other major oil states to meaningfully slow the shale juggernaut, low prices might need to be in place for perhaps a few years, so that there is enough labor forced out of the sector and equipment scrapped, making any rebound in supply more difficult. For now, there is enough talent still on staff and equipment in place across all the major shale plays to allow for a quick return to drill for oil and gas. In addition, a partial price recovery now could reopen the capital markets to the sector, giving funding to producers to keep drilling, particularly as hedge flows would increase in a higher price environment just as the Northern Hemisphere comes-off peak demand season.

On top of all of this, OPEC has a problem internally – who is going to cut? In our view, it certainly would not be Iran and Iraq, which combined might be adding over 1.5-m b/d of incremental supply over the next twelve to eighteen months. While entirely plausible for the Saudis to cut this fall, that might be more a function of its own internal consumption waning seasonally. The Kingdom burns up to 1-m b/d of crude during the peak summer months for power generation, though that begins fading in September.

For Moscow and Riyadh to reach an agreement, it would essentially mean a Saudi cut – but what quid pro quo could be achieved any time soon? A change in Iranian and Iraqi behavior? A change in the Syrian regime? This seems unlikely, in our view.

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