By Matein Khalid: Chief Investment Officer and Partner at Asas Capital
The global economy is the biggest variable for petroleum demand growth in 2020. While a US-China phase one trade deal has meant that Wall Street has priced out fears of an imminent US recession, the fact remains that Chinese GDP growth has fallen to its lowest level in a generation, Europe’s industrial malaise is structural, India’s shadow banking crisis presages a vicious credit crunch and the World Bank has gone public with its alarm on the $55 trillion borrowing binge in the emerging markets. All is definitely not hunky dory for global petroleum demand, now just above 100 million barrels a day.
There is no doubt in my mind that the biggest shock for the wet-barrel crude oil market in 2020 will be a slow decline in demand growth as China and India’s banking/credit crunch woes take their toll on the world’s first and second largest oil consumers. If global demand for crude declines sharply, expect another swift, brutal sell off in Brent crude that not even Saudi Arabia’s willingness to resume its role as OPEC’s swing producer (with an opportunistic, erratic, reluctant ally in the Kremlin) will be able to contain. This means OPEC’s 1.7 MBD output cut, brokered in Vienna in early December by Crown Prince Abdelaziz bin Salman and Alexander Novak, may not be sufficient to balance the market. If that proves to be the case, all bets are off on oil prices, as was the case that fateful November in 2014.
Of course, Saudi, Russian, Iraqi and Nigerian politics will determine the success of the recent OPEC + output cut pact next year. The surge in US shale oil growth since 2015 has placed a huge pressure on OPEC’s exposure to the global oil glut, as has the escalation in geopolitical tensions in the Gulf, the Levant, Yemen and North Africa. The resurgence of sectarian violence in Iraq, the protracted civil war in Libya and political violence in Nigeria’s Niger Delta and northeast Madugiri state (home of Boko Haram) makes it difficult for beleaguered, cash strapped government to agree to draconian Saudi-Russian brokered OPEC output cuts. US “maximum pressure” sanctions have strangled Iran’s oil exports to a mere 250,000 barrels a day. If US shale growth surges again in 2020, there is a high probability that the OPEC output cut breaks down, as the burden of quota compliance falls disproportionally on Saudi Arabia, the UAE and Kuwait.
Saudi Arabia has an obvious sovereign national interest in higher crude oil prices. It does not want a plunge in the share price of the Saudi Aramco IPO at a time when 5 million Saudi citizens have borrowed untold billions of riyals from local banks to buy shares in the kingdom’s energy crown jewel. In any case, Brent is still an ominous $20 a barrel below the Saudi government’s budget breakeven price. Saudi Arabia faces a 6% budget deficit to GDP ratio even at current post-Vienna deal prices. The 2019 State Budget is the most expansionary since the petrodollar bonanza era in the late 1970s. Saudi Arabia is also fighting an expensive war in Yemen. The kingdom also endured a Houthi/Iran drone and missile attack on its oil processing complexes in the Eastern Province, the ultimate nightmare for the oil market – yet no supply shock emerged thanks to the engineering/reconstruction excellence of Saudi Aramco and the global oil markets conviction that Permian Basin in Texas has limitless reserves of shale oil.
If US shale output does not decline and a Indian/Chinese credit shock triggers a 1998/2008 style meltdown in the global economy, not even Saudi Arabia, the powerbroker of OPEC with the lowest drilling costs on the planet and the only real spare capacity in the cartel, will be able to prevent a catastrophic fall in crude oil prices. This is even before we consider the seismic impact of electric vehicles on the demand for fossil fuels. This bearish macro scenario haunts the valuation of oil and gas supermajors on Wall Street, now collectively valued less than Microsoft, let alone Apple, on the NYSE. Big Oil knows a global glut of black gold/Texas tea is on the horizon in 2020 and beyond.
The demand for OPEC crude will be 29.6 MBD in 2020, as estimated by OPEC’s own secretariat economists in Vienna. This means if Venezuela and Iran, offline due to US sanctions now, were to re-enter the oil market once regime behavior (or regime change) shifts international relations, a new supply-demand equation will impact the international oil market.
Despite three successive Federal Reserve FOMC rate cuts in 2019 and a US-China trade ceasefire, I cannot envision a substantial drop in the US dollar, a potential ballast for oil prices. Europe’s industrial malaise simply will not prevent a secular bull market in the Euro, though 1.18 is possible if Madame Lagarde arranges fiscal stimulus with Berlin and the Elysée Palace.
The US Presidential election in November 2020 is also a critical event risk for the oil market. If President Trump is not re-elected, a Democratic White house (Biden? Warren? Sanders?) could well resurrect JCPOA in a bid to seek diplomatic rapprochement with Iran, as Obama did in 2015. A Democratic White House could also mean chillier US relations with the Saudi Crown Prince’s Royal Court in Riyadh. This geopolitical scenario will be massively crude oil negative.