Head of Commodity Strategy
Summary: Crude oil slumped to a five-month low on Monday before surging by more than 12%. These developments which broke the relative calm seen since June had three major actors: Libya, Covid-19 and OPEC+. The renewed weakness was, just like April, driven by weakening demand and rising production before renewed focus on OPEC+ support helped arrest the slide.
What is our trading focus?
OILUKJAN21 – Brent Crude Oil (January)
OILUSDEC20 – WTI Crude Oil (December)
XLE:arcx - Energy Select Sector SPDR Fund
XOP:arcx - SPDR S&P Oil & Gas Exploration and Production
XES:arcx - SPDR S&P Oil & Gas Equipment & Services
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Crude oil slumped to a five-month low on Monday before surging by more than 12%. These developments which has broken the relative calm seen since June had three major actors: Libya, Covid-19 and OPEC+. The renewed weakness was, just like April, driven by weakening demand and rising production before renewed focus on OPEC+ support helped arrest the slide.
A wave of new virus-lockdown measures in Europe and a rapid rise in new cases across the U.S. have raised concerns about the near-term trajectory for oil demand. At the same time and potentially more troubling for OPEC+ has been the rapid recovery in Libyan oil production from less than 100,000 barrels/day in September to the current 800,000 barrels/day.
These developments have in our opinion sharply reduced the likelihood of OPEC+ going through with the agreed 1.9 million barrels/day production increase from January. The rally since yesterday was in fact triggered by reports that the Russian oil minister was discussing a delay with local producers. Something we think is close to an absolute given considering the recent deterioration in the short-term fundamental outlook.
Adding to the pressure on the price and OPEC+ has been U.S. production which after a very active and disruptive hurricane season have proven quite robust and despite sub-$50 prices have started to recover. Adding to this emerging signs that the strong demand from China that helped speed up the rebalancing process in recent months has started to fade.
Brent crude oil which has traded sideways since June, broke lower last week as the fundamental outlook continued to deteriorate. Crude oil and commodities in general do not like equities have the luxury of being able to roll forward expectations as supply and demand need to balance every day. With oil in particularly this means that once it is out of the ground, it needs to be stored or consumed. If storage builds to rapid, the price may suffer, especially at the front end of the curve in order to attract interest for storage plays from owners of ships and landlocked storage facilities.
We are, however very unlikely to witness a renewed collapse in crude oil prices similar to what we saw back in April. Asian demand remains robust while fuel demand in the U.S. is unlikely to be hurt too much due to the lack of appetite for lockdowns.
With this in mind we suspect that Brent crude oil may continue to trade rangebound with a slightly negative bias. The current range is $35.50/b to $42.50/b with the cure being either additional action from OPEC+ or news about the rollout of a vaccine.
Looking beyond the current and somewhat challenging outlook are the prospect of a future recovery. Once the current overhang of spare capacity has been reduced and demand return to trend-growth above 100 million barrels/day, the lack of investments from oil producers will likely lead a strong rebound in prices. Once the market begins to balance the ten oil majors (ex. Aramco) and ten biggest U.S. independent producers may start to claw back some of the near $800 billion in market cap they have lost this year.
While the S&P 500 trades higher by a few percent year-to-date some of the major energy related ETF’s have shed more than 50% of their value. It highlights a sector not only challenged by lower oil prices but also the rush into “green” investments at the expense of traditional energy providers.
While investors seek green investments they ignore the fact that fossil fuels, like it or not, will remain a key source of energy for decades to come. Lack of current investments into the sector therefore risk driving prices of fuel beyond higher beyond 2021 at a time where the global economy can least afford it.
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
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