Complex Made Simple

Expert opinion: The Brent crude snapback is all too real!

By Matein Khalid: Chief Investment Officer & Partner at Asas Capital

Crude oil prices have risen 10% in the first trading week of 2019 after a savage 40% fall in the last three months on global growth and supply glut angst. There are multiple reasons for the snapback in Brent crude form its $52 low to $58 a barrel as I write (though still dramatically below the $86 peak price in early October 2018).

One, Saudi Arabia has made it clear that it intends to play the role of OPEC’s swing producer once again to stabilize prices. Saudi Arabia will use its spare capacity to generate the bulk of the 1.2 million barrels a day (MBD) output cut the kingdom negotiated at the last OPEC ministerial meeting in Vienna on December 7. The kingdom’s tanker lifting data show at least a 500,000 fall in Saudi exports. Iran and Venezuelan oil shipments have also fallen due to financial distress and Russia has agreed to cut 300,000 barrels, though West Siberian permafrost leads to a seasonal fall in Ural crude exports. The UAE and Kuwait are traditional allies of Saudi Arabia in OPEC and can be expected to demonstrate compliance with the kingdom’s Vienna output cut pact.

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Two, the 312,000 US payroll growth data in December and the People’s Bank of China’s banking reserve ratio cut to boost credit growth in the Middle Kingdom have priced out global recession fears in the oil market. There was a frenzy of short covering in the West Texas futures contract in New York and the North Sea Brent contract in London as traders realized that Saudi Arabia and the Kremlin were deadly serious to prevent a 2008/2014 style oil price crash and deliver credible supply cuts that would balance the wet barrel (physical oil trading) market at the same time as Washington and Beijing would inject monetary stimulus to prevent asset price contagion.

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Three, the Federal Reserve’s decision to reduce its projected interest rate hikes in 2019 from three to two and an Italian-EU budget deal has led to a fall in the US Dollar Index from its 97 high. This has led to a firmer bid in the oil futures market. The protracted US government shutdown, the Democratic majority in Congress and the risk of impeachment for President Trump after the Mueller probe goes public is a sword of Damocles for the US dollar that could well boost Brent crude to $65.

Four, apart from cautious optimism on the Chinese economy, Wall Street equities have moved sharply higher on hopes of a US-Chinese trade agreement even though Chinese retail sales and industrial production growth data were at dismal decade lows. China has agreed to boost its US soyabean imports and full Vice-Premier led the latest trade negotiations in Beijing. Wall Street has concluded that Beijing does not want a global recession as much as an embattled, politically weakened President Trump – and a trade pact will help eliminate this draconian risk for both the People’s Republic of China and the United States.

The caveat remains that it is difficult for Brent crude to trade above $70 a barrel for a sustained period since a shale oil output surge in the Permian Basin in West Texas and the Bakken in North Dakota means US output could well rise above 12 MBD in 2019 – and rise by a million barrels a day each year until 2025.

This will make the United States the most powerful marginal supplier of shale oil and LNG to the world. It will also make OPEC a price taker, not a price maker in the global oil market.

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New pipelines in Texas and Louisiana will help transport Permian Basin oil to the Gulf Coast refineries. This is the reason Goldman Sachs cut its Brent forecast to $62.5 for the next three months, down from a previous $70. Activist hedge fund manager Paul Singer’s $2 billion takeover bid for the Colorado shale oil and gas producer QER Resources makes total strategic sense to me. The company was grossly undervalued, relative to its reserves on the stock exchange. This is the time to drill for black gold at a discount on Wall Street! After all, QER Resources shares soared 40% on Singer’s takeover bid. Merger mania is coming to the shale oil and gas world. The Anglo-Persian Oil Company, now known by the politically correct acronym of BP, just discovered a billion barrels of oil in the Gulf of Mexico. Is BP undervalued?