Well, the big story today is again crude, as Brent topped $50 (before pulling back) putting pressure on the dollar in what will continue to be the most important market tug-of-war when it comes to how risk is bid.
Earlier this month, I explained that everything seems to be trading off of oil, which isn’t surprising. It’s a proxy for the strength of the deflationary impulse that is still casting a pall over markets eight years after the crisis. It’s also an important indicator in terms of assessing the geopolitical landscape and as I never tire of reminding investors, you can’t understand today’s markets without understanding geopolitics.
Crude is benefiting from what looks like shifting sentiment in terms of how the Street is looking at the fundamental backdrop. In a high profile call, Goldman last week called for “a sudden halt to the oil market surplus.” Similarly, Barclays sees the market swinging to a supply deficit next year. As noted here on Monday, Morgan Stanley and Deutsche aren’t as sanguine.
Here’s what Credit Suisse had to say on Wednesday:
“US crude oil stocks fell ~4.2 mbs last week, and are down ~6.3 mbs this month (in contrast to the more normal small May build): In addition, inventories in Canada (about which information is far from complete) appear to have fallen by, we think, at least ~10 mbs in the last two weeks, since the wildfires near Fort McMurray have for more than 20-days shut in some 1.05 Mb/d. We are forecasting a global inventory draw of ~180 mbs for H2 2016.
“Big picture it seems as if a global re-balancing of supply and demand is nigh, and Opec’s job is being done (however tardy) by market forces: While one can never know these things for sure, it strikes us that next week Thursday’s Opec meeting in Vienna will be a bit of a non-event from a global oil fundamentals perspective. Indeed, with fewer than eight days to go before delegates arrive in Vienna, there have appeared very few stories on newswires citing ‘sources’ about producers working on a deal to “freeze” (let alone “cut”) production. “
Ah, yes. OPEC. The cartel that everyone is sure is no longer a cartel. Next week’s meeting in Vienna is set against a backdrop of deteriorating relations between the Saudis and the Iranians whose eternal sectarian feud is being waged in the oil markets as well as in Syria and Yemen. You’re reminded that even though it’s expected to be a dud in terms of securing a production freeze, the meeting nonetheless offers an important glimpse into the future.
This is the first meeting attended by Saudi Arabia’s newly-appointed Energy Minister Khalid al-Falih who was installed this month for Ali al-Naimi at the behest of Deputy Crown Prince Mohammad bin Salman (or, “MbS” colloquially).
While al-Falih shares al-Naimi’s desire to keep the taps open to preserve market share, some speculate that the new Minister’s many hats suggest the Saudis no longer want anything to do with the cartel. Here’s what Reuters had to say in their preview of next Thursday’s meeting:
“Since his appointment on May 7 as head of a new mega-ministry - overseeing energy, industry, mining, atomic power and renewables - Falih has toured six state firms, met the South Korean premier, the Canadian foreign minister and Gulf industry ministers, and opened a gas turbine plant.
“To fellow members of the Organization of the Petroleum Exporting Countries, that speaks volumes. Unlike his predecessor Ali al-Naimi, Falih may not have much time for OPEC.
"’That is going to keep Falih busy and I imagine his priorities will be economic reforms and integrating new portfolios, said Richard Mallinson, geopolitical risk analyst at the think-tank Energy Aspects.”
Still, they’ll be pressure on Falih to help the cartel's weaker players stay afloat. Reuters ran another piece this week describing the rather dire financial situation facing some of the group's less affluent nations who borrowed billions against their oil output in better times and are now forced to channel nearly everything to international lenders:
“Poorer oil-producing countries which took out loans to be repaid in oil when the price was higher are having to send three times as much to respect repayment schedules now prices have fallen.”
“This year Angola, Nigeria, Iraq, Venezuela and Kurdistan are due to repay a total of between $30 billion and $50 billion with oil.”
“Repaying $50 billion required only slightly over 1 million barrels per day (bpd) of oil exports when it was trading at $120 per barrel but with prices of around $40, the same repayment would require exports of over 3 million bpd.”
Qatari oil minister Mohammed bin Saleh al-Sada echoed the sentiments expressed by those who think the market can’t tolerate the price slump for much longer.
"The oil market is recovering slowly but steadily. Luckily, the fundamentals show it is heading in the right direction," he said this week. "I don't think we are yet at a fair price."
Probably not. And the Saudis probably don’t think so either, but they’re going to make a go of restructuring the economy before they’ll move to cut production. It likely won’t work, but Riyadh seems to reckon it’s worth a shot as opposed to any plan that would see Iran rake in even more extra cash than they already are.
“[The Saudis are] applying pressure on Iran wherever they are able to do so, to limit its political and economic influence,” Shashank Joshi, a senior research fellow at the Royal United Services Institute in London told Bloomberg. “Oil policy [is] one of the instruments,” added the Gulf Research Center’s Mustafa Alani.
I continue to believe that the fundamentals here are still far too bearish to justify the dramatic rally off of the January lows. Have a look, for instance, at the US inventory numbers compared to history:
If I’m right and crude plunges again just as the Fed hikes rates, it’s going to create a very tough environment for EM and for risk in general. Especially considering where we are on the S&P. As Goldman points out, companies with weak balance sheets are going to get hit hard if there’s another energy rout, especially considering how leveraged everyone is. On the other hand, S&P companies with strong balance sheets are trading at 22X. Not exactly a bargain.
I’ll close with Citi’s take on the headwinds crude still faces as it tries to march higher:
“Crude oil prices flirt with $50 as supply disruptions stack up on top of accelerating declines in non-OPEC oil production. US oil inventories have largely topped out and should decline through the summer. Citi has revised up its near-term oil price outlook, accelerating the time to reach $50 Brent. Meanwhile, the return of US oil production on the back of higher oil prices, cost deflation across the sector, and Saudi intentions to raise crude production and exports are headwinds to a price rally, and suggest a volatile upward trajectory for prompt as well as deferred prices.”