With oil prices spiking nearly 10% from last Friday’s sudden, capitulation “flash crash” which was perhaps driven by Pierre Andurand liquidating his entire long book, there has been a scramble by analysts to “fit” the narrative to the price action and the sudden change in momentum, most notably by Goldman, which continues to pump one after another bullish crude note, we suppose because Goldman’s prop trading desk still has some oil left to sell to clients. However, is the recent bounce an indication of a sustainable direction shift, facilitated by a another even more acute round of OPEC jawboning even as shale oil production continues to grow, or just a dead cat bounce?
According to Bloomberg FX commentator Mark Cudmore, the answer is the latter as he explains in his latest overnight “macro view” note.
Traders’ New Love for Oil Isn’t Basis for Marriage: Macro View
What a difference a week makes. Oil prices are more than 9% above last Friday’s capitulation low. The bounce has legs in the short-term but it doesn’t alter the long-term bearish story.
Recent newsflow justifies this rally. U.S. oil inventories just showed their largest drop of 2017, and a fifth consecutive weekly decline. OPEC is expected to extend production cuts when it meets May 25. Goldman reiterated its bullish call for an imminent supply deficit.
February’s record speculative long position has been roughly halved. The market technicals appear healthy and fresh for a sustained bounce.
That’s the short-term outlook. But at some point the much bigger picture will dominate again and that entails a far more negative skew on the situation.
As Bloomberg oil strategist Julian Lee wrote, the OPEC production cuts would need to be significantly deepened to remove the OECD stockpile by year-end — especially in the face of increased output from Libya and Nigeria.
OPEC itself just raised its forecast for 2017 production from non-members by 64%. U.S. Baker Hughes rig count has climbed for the past 16 weeks.
U.S. stockpiles may now be showing a steady decline – but only from an extreme record. They are still above any level seen before this year.
The important backdrop is that extraction from shale continues to become cheaper and more efficient all the time, lowering the price point above which production will rapidly increase to flood the market with supply.
And simultaneously, there’s the slow and steady growth of renewable/alternative sources of energy as well as technological improvements in energy storage and transfer. That’s without mentioning the C-words: carbon and climate change. Even without Trump’s support, efforts to reduce emissions and the use of oil-derived products are garnering more and more support.
All this boils down to a long-term, structurally bearish story. Rallies can last for weeks, or even months. But don’t get too attached. They won’t carry you through to old age.
Separately, here is Commerzbank doubling down on the bearish narrative with its own overnight note, it which it warns that should OPEC extend output curbs on May 25, it “is unlikely to be more successful than the cuts implemented so far in the longer term,” according to the bank’s head of commodity research, Eugen Weinberg. He also points out, logically, that the extension may “considerably tighten the market in the second half, yet will only boost non-OPEC production.“
The decisive factor, if only for the time being, technical positioning, as algos continue to enjoy stopping out whichever side is positioned more heavily in the oil price debate. – Zerohedge
As pessimism sweeps over the oil market, a few prominent voices are unbowed, arguing that the market is well on its way towards balance.
Goldman Sachs’ head of commodities Jeff Currie said at an S&P Global Platts Conference in London this week that investors should probably be going long on crude oil because the market is already in a supply deficit. He pointed to the futures market, where the curve could be headed into backwardation – a situation in which near-term oil futures trade at a premium to contracts further out. That structure points to concerns about a deficit in the short run, which is why front month contracts would trade at a higher price than deliveries six or twelve months away.
But the backwardation is also a symptom of fears over long-term oil prices. Goldman Sachs has consistently argued that crude prices could remain relatively low for years to come as the cost of production has shifted lower. So, lower long-term prices have pushed the back end of the futures curve lower, with near-term prices trading higher.
There is a feedback effect from the market shifting into backwardation. If spot prices are above long-term prices, then fewer companies will be willing to lock in next year’s production at those lower prices. Without industry-wide hedging, the ability to grow production is diminished. Or, as Goldman Sachs put it in its latest research note, “fear of long-term surpluses reinforces near-term shortages.”
Putting some of the jargon aside, Goldman is simply arguing that the oil market will be much tighter this year than most people seem to think. The investment bank forecasts returns on commodity prices on the order of 13.3 percent over the next three months and 12.2 percent over the next 12 months.
That prediction is based not just on the idiosyncrasies of paper trading, but ongoing improvements in the physical market. For example, Goldman predicts a rather modest inventory build of just 6 million barrels (crude oil and refined products) across the U.S., Europe, Japan and Singapore between March and April, which is much lower than the typical 16-million-barrel increase for this time of year.
Goldman also cautions everyone not to read too much into the exceptionally high inventory level in the U.S. because the U.S. has the lowest cost storage capacity, and as such, it will be “the last to draw.” Also, the U.S. has the most “visible” data, so there are a lot of drawdowns happening elsewhere in the world out of full view of market analysts. In short, U.S. inventories are a “lagging indicator of the rebalancing.”
And even that lagging indicator is starting to improve. The EIA reported on Wednesday a surprise drawdown in oil inventories, with stocks dropping by 5.2 million barrels, much more than the markets had anticipated. That led to strong gains for WTI and Brent, both of which were up nearly 4 percent during midday trading on Wednesday. Even better, gasoline stocks did not rise, bolstering the view that the drawdown was for real and not just a shifting of product from crude storage to gasoline storage.
If U.S. inventories are the last to draw down, as Goldman Sachs says, then the fact that they are indeed drawing down lends some credence to the investment bank’s assessment.
The IEA agrees with Goldman’s view, arguing that supply is already exceeding demand in the second quarter, and the deficit will grow in the second half of the year as long as OPEC extends its production cuts. “It is starting to become clear that if the objective of the OPEC cuts was to flip the market from surplus into deficit that is now slowly beginning to happen,” the IEA’s head of oil analysis, Neil Atkinson, said at the Platts London Conference.
So why did prices sell off so sharply last week? As they have mentioned before, Goldman chalks it up to technical trading and sentiment, not because of poor fundamentals. They admit that the market is balancing slower than everyone expected, but the investment bank stood by its prediction that the oil market is tightening. – Nick Cunningham
“Well he would say that, wouldn’t he.” Mandy Rice Davies at the time of the Profumo scandal, 1963.
OPEC has mounted yet another charm offensive as a result of last week’s roughly 5% crash in the global price of crude. As was widely reported by the wire services, the headline from Saudi Oil Minister Khalid al-Falih to the effect that the Saudis would do whatever it takes to end the global supply glut of crude hit the world press on 8 May and gave markets a short-term boost. Al-Falih was quoted as saying that global oil markets had improved from 2016 lows when crude prices fell below the $30 per barrel level for a reason. “I believe the worst is now behind us with multiple leading indicators showing that supply-demand balances are in deficit and the market is moving towards rebalancing. We should expect healthier markets going forward.” He also expected global oil demand to grow roughly equivalent to last year with both China and India remaining moderate to strong consumers of Saudi black gold. What’s more, al-Falih stated very firmly that the six-month extension is all but a done deal and even suggested that OPEC is looking at extending the cuts beyond the end of 2017.
Well, he would, wouldn’t he? But is the market believing it? As can be gleaned from the weekly COT (Commitments of Traders) reports from the CFTC (U.S. Commodity Futures Trading Commission), the big bullish bet on crude for this cycle really began in November 2016 amid noise out of OPEC regarding the cuts, but before any concrete action actually occurred. As at mid-November 2016, the bulls outweighed the bears by about 276,000 WTI contracts, with the peak recorded on February 21 2017 at just over 566,000 contracts. That was an easy double in just about three months. The latest trading data, however, shows that hedge funds and other speculators have decreased their bullish bets, taking their net longs down to about 373,000 contracts, the lowest level since the OPEC deal was announced last year. That’s a 34% drop from peak to current trough. Put another way, OPEC credibility has taken a hit of about one-third.
The media must assign reasons for daily movements in the price of crude: the OPEC deal is on/is off; OPEC will extend into 2017, no it’s going to be 2018; global economic growth will be higher than anticipated this year resulting in more crude being consumed/no it won’t; demand for crude is rising faster than previously forecast especially in emerging markets/no it isn’t, etc. In reality, price movements are largely random and largely in the realm of higher mathematics as speculative funds’ algorithms are very similarly structured and tend to respond in concert as the crash last week attests.
So if OPEC is huffing and puffing and the funds aren’t buying it, what other measure can prove or disprove what appears to be mounting pressure for a longer-term downward leg in WTI? Interestingly, during the big build-up in hyper-bullishness from November 2016 to February 2017, the volatility of crude as measured by the CBOE oil VIX index (OVX) decreased markedly (see chart). The VIX is sometimes called a fear barometer and sometimes a complacency indicator, since it derives its value from the volatility input in crude oil futures/options pricing. Like its U.S. stock market VIX equivalent, which tracks the S&P 500 and has shown similar historic lows, the big question is why, and the answer is that trending markets both on the upside and the downside reflect higher conviction and lower volatility. Note, however, during this cycle the big down move in the OVX from the mid-50s in November 2016 to the mid-20s in February, a decline of almost 55%. Also note that the OVX has now turned higher, rising fairly sharply into the mid-30s as the correction began in earnest last week.
Higher OVX, of course, means higher volatility and as a result the higher the probability of bigger price moves. Combine that with lower futures open interest and it’s clear that OPEC’s pronouncements are going to be falling on fewer and fewer receptive ears. – Brian Noble
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