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    Forward Guidance

    OPEC To The Rescue | Rory Johnston’s Cautious Bull Case For >$80 Oil

    Tue Jul 18 2023
    Oil MarketDemand and SupplySaudi ArabiaOPECChinaStrategic Stock BuildingGuyanaUS DemandAir TravelRussian Production CutsCrude CharacteristicsSpeculator PositioningBackwardationPrice Outlook

    Description

    The episode covers the fluctuations in the oil market driven by speculation, demand and supply imbalances, Saudi Arabia's impact on oil prices, uncertainty surrounding OPEC and China, strategic stock building in China, game-changing oil production in Guyana, US demand and Russian production cuts, air travel and Russian production cuts, impact of crude characteristics and speculator positioning, speculator positioning and market dynamics, backwardation and inventory levels, and price outlook and economic factors.

    Insights

    Oil Market Fluctuations

    The oil market has been bouncing back and forth between supply and demand deficits and surpluses for the past six months. The price fluctuations in the market seem to be driven by speculation rather than fundamental factors.

    Demand and Supply Imbalances

    On the goods and industrial side, demand has been weak, particularly in diesel and petrochemicals industries. However, fuels like gasoline and jet fuel have performed better on the services and consumer side.

    Saudi Arabia's Impact on Oil Prices

    Saudi Arabia has implemented a unilateral voluntary cut in oil production, while also announcing a complementary cut to export. Saudi Arabia's control over the market is driving higher oil prices.

    Uncertainty Surrounding OPEC and China

    OPEC still has the potential to make cuts in oil production, but it's unlikely they will use them. China's reopening has not led to a significant increase in oil demand as expected.

    Strategic Stock Building in China

    Chinese authorities are likely engaging in strategic stock building, leading to unrealistically high inventory numbers. The days of oil prices reaching $120 or $150 per barrel are unlikely to happen again due to various factors such as US shale slowdown and increased global supply from countries like Guyana, Canada, Mexico, and Brazil.

    Game-Changing Oil Production in Guyana

    Guyana is experiencing an explosion of oil production, making it a game changer for the country. Guyana is expected to become the largest per capita oil producer on the planet, reaching around a million barrels a day by 2027-2028.

    US Demand and Russian Production Cuts

    US is not a major source of demand growth, most growth expected from China, India, and rest of emerging Asia. Air travel activity trending around pre-COVID levels but not surpassing it as expected.

    Air Travel and Russian Production Cuts

    Efficiency gains in the airline industry continue to drive fuel consumption down. Russia's commitment to production cuts is questionable, as they have a history of not following through on promises.

    Russian Production Cuts and Market Manipulation

    Tanker trackers show that oil exports haven't fallen despite claimed production cuts. Both bulls and bears have arguments about the impact of breaching the price cap.

    Impact of Crude Characteristics and Speculator Positioning

    Crude oil is not a monolith and has different characteristics such as API gravity and sulfur content. The net speculative position in the oil futures market dropped to its lowest level since the opening of COVID, indicating reduced bullish sentiment.

    Chapters

    1. Oil Market Fluctuations
    2. Demand and Supply Imbalances
    3. Saudi Arabia's Impact on Oil Prices
    4. Uncertainty Surrounding OPEC and China
    5. Strategic Stock Building in China
    6. Game-Changing Oil Production in Guyana
    7. US Demand and Russian Production Cuts
    8. Air Travel and Russian Production Cuts
    9. Russian Production Cuts and Market Manipulation
    10. Impact of Crude Characteristics and Speculator Positioning
    11. Speculator Positioning and Market Dynamics
    12. Backwardation and Inventory Levels
    13. Price Outlook and Economic Factors
    Summary
    Transcript

    Oil Market Fluctuations

    00:04 - 06:47

    • The oil market has been bouncing back and forth between supply and demand deficits and surpluses for the past six months.
    • The price fluctuations in the market seem to be driven by speculation rather than fundamental factors.
    • There is frustration among investors due to the lack of a clear directional narrative in the market.
    • The speaker approaches the market by focusing on what is not happening rather than what is happening.
    • Oil has been trading flat to down since September of last year, with occasional rallies and rebounds.
    • Biden has not backed down, but China has reopened, which may impact oil trading.
    • The speaker considers themselves cautiously bullish at this stage, expecting oil prices to stay within a certain range.
    • A perfect constellation of events would be needed for oil prices to reach triple digits again.
    • Demand weakness and increased supply have shifted the balance in favor of bears rather than bulls.
    • Russian barrels of oil have not left the market as expected; instead, they have been sold to other countries.
    • Demand for oil was affected by a macro slowdown and high prices.

    Demand and Supply Imbalances

    06:32 - 13:46

    • On the goods and industrial side, demand has been weak, particularly in diesel and petrochemicals industries.
    • However, fuels like gasoline and jet fuel have performed better on the services and consumer side.
    • The shift from services spending to goods during COVID caught many off guard but was expected to unwind.
    • Oil demand should be growing at a million to a million and a half barrels a day, so being back at pre-COVID levels is an exceptionally low bar.
    • Growth in oil demand has slowed since the middle of last year due to changes in consumer behavior and work-from-home trends.
    • The aviation industry's efficiency gains have masked the need for increased jet fuel demand, which is still below pre-COVID levels by about 10%.
    • The recent increase in oil prices can be attributed to OPEC+ continually cutting production over the past few months.
    • The tracking of OPEC cuts has become more complex with official quotas, voluntary cuts, and unilateral cuts from Saudi Arabia.
    • Saudi Arabia's unilateral cut in production has contributed to the current bullish environment.

    Saudi Arabia's Impact on Oil Prices

    13:22 - 19:55

    • Saudi Arabia has implemented a unilateral voluntary cut in oil production, while also announcing a complementary cut to export.
    • Saudi Arabia has effectively reduced its oil production by 2 million barrels per day, with the potential for further cuts.
    • The reduction in Saudi oil supply is even larger when accounting for domestic consumption during the summer months.
    • Saudi Arabia's control over the market is driving higher oil prices.
    • Historically, Saudi Arabia has been reluctant to unilaterally cut production due to the negative impact it had on prices in the past.
    • Other members of OPEC have a spotty record when it comes to actually implementing production cuts.
    • There are some core allies within OPEC, such as Kuwait and UAE, that have been consistent in cutting production.
    • The mid-80s saw Saudi Arabia cutting back production to make way for new supply from the North Sea, leading to a bear market.
    • There is concern about relying too heavily on Saudi Arabia's actions as they can change their stance quickly if prices don't increase.
    • While Saudi Arabia still has room for more cuts, it is unlikely they will use them unless necessary.

    Uncertainty Surrounding OPEC and China

    19:36 - 26:27

    • OPEC still has the potential to make cuts in oil production, but it's unlikely they will use them.
    • The market is uncertain about what OPEC will do next.
    • When OPEC cuts production, it may remove some barrels from the market, but it also means that more production can come online when the price of oil spikes.
    • High and volatile oil prices in early 2022 were due to concerns about inventory levels, sluggish shale production, and OPEC members struggling to meet their quota commitments.
    • Precautionary buying contributed to overcorrection in oil prices at the beginning of 2022.
    • The oil market is not good at looking through anything; it directly responds to supply and demand imbalances.
    • If Saudi Arabia maintains unilateral cuts, it could force prices higher by reducing inventories.
    • China's reopening has not led to a significant increase in oil demand as expected.
    • Chinese fuel consumption numbers are based on apparent demand estimates, which may be overstated due to strategic stock building by Chinese authorities.

    Strategic Stock Building in China

    26:01 - 32:42

    • Chinese authorities are likely engaging in strategic stock building, leading to unrealistically high inventory numbers.
    • Chinese inventories and the USPR (US Strategic Petroleum Reserve) are not considered normal commercial inventories as they are driven by government edict.
    • Chinese demand for oil is primarily from government entities, not consumers or businesses.
    • Gasoline and jet fuel consumption in China is doing reasonably well, while diesel and NAFTA (North American Free Trade Agreement) consumption is not strong.
    • The apparent demand numbers in China may not accurately reflect the actual underlying consumer and business demand.
    • Bulls and bears in the oil market have conflicting views on where prices will go, but trading has been mostly sideways for the past six months.
    • The days of oil prices reaching $120 or $150 per barrel are unlikely to happen again due to various factors such as US shale slowdown and increased global supply from countries like Guyana, Canada, Mexico, and Brazil.
    • OPEC's constraints may ease if oil prices rise significantly, but there are changing dynamics in how OPEC and Saudi Arabia interact with the market.
    • The explosion of oil production in Guyana is significant for companies like Hess but may not be as impactful on the global picture compared to major producers like Saudi Arabia.

    Game-Changing Oil Production in Guyana

    32:19 - 38:51

    • Guyana is experiencing an explosion of oil production, making it a game changer for the country.
    • Guyana is expected to become the largest per capita oil producer on the planet, reaching around a million barrels a day by 2027-2028.
    • The growth rate in Guyana's oil production is impressive, with an estimated increase of 200,000 barrels a day year on year.
    • The market doesn't clear based on total volumes but rather on marginal basis, so Guyana's growth is significant in maintaining balance in the market.
    • US production has seen less incremental unprofitable growth compared to previous years but remains one of the largest sources of incremental supply globally.
    • US production has increased by about a million and a half barrels a day this year, with natural gas liquids playing a significant role in this growth.
    • US demand growth has been relatively stable, although it was down by around a hundred thousand barrels a day as of April.
    • Most of the expected demand growth comes from countries like China, India, and other emerging Asian economies.

    US Demand and Russian Production Cuts

    38:35 - 45:27

    • US is not a major source of demand growth, most growth expected from China, India, and rest of emerging Asia
    • Strong demand in the US for gas, land, and jet fuel, weak demand for distillate and fuel oil
    • Question of whether consumer strength can hold the market together long enough for industrial goods to recover
    • If consumer and services gains are held together by robust job markets, US may be in a net growth position
    • If industrial and goods side continues to suffer, gasoline and jet fuel may decline leading to a bearish market
    • Oil demand doesn't typically contract on an absolute basis in a recession
    • High oil prices contributed to erosion of consumer spending during the Great Financial Crisis
    • Consumer sentiment inversely correlated with oil price
    • Emerging markets show slower growth in oil demand compared to China's strong bounce back
    • Supply growth likely to fall due to Saudi and OPEC cuts, question remains on future demand growth
    • Air travel activity trending around pre-COVID levels but not surpassing it as expected

    Air Travel and Russian Production Cuts

    45:02 - 51:42

    • Revenue per mile is higher now than in 2019.
    • America to Europe air travel is growing rapidly.
    • China to the rest of the world has lagged behind in air travel demand.
    • Chinese domestic flight activity has returned to pre-COVID levels, while international activity is still below.
    • Efficiency gains in the airline industry continue to drive fuel consumption down.
    • Jet fuel demand accounts for around 8-9% of global demand and was the fastest-growing component before COVID.
    • The major sources of future oil demand growth are uncertain, with petrochemicals being dour and flight recovering slowly.
    • Russia's commitment to production cuts is questionable, as they have a history of not following through on promises.
    • Russia claims to cut production by 500,000 barrels per day but exports haven't fallen according to tanker trackers.

    Russian Production Cuts and Market Manipulation

    51:22 - 58:14

    • Tanker trackers show that oil exports haven't fallen despite claimed production cuts.
    • Russia announced a cut of 500,000 barrels per day in addition to the production cuts.
    • There is uncertainty about whether this export cut is separate from or confirming the production cuts.
    • The market will wait for tangible evidence of cuts before integrating them into prices.
    • Russia's history of market manipulation makes it difficult to trust their commitments.
    • The ban on Europe and America buying Russian crude affects shipping and logistics, not imports themselves.
    • If the price cap is breached, transportation capacity may tighten, putting downward pressure on other crude grades.
    • Both bulls and bears have arguments about the impact of breaching the price cap.

    Impact of Crude Characteristics and Speculator Positioning

    57:56 - 1:04:52

    • Western Canadian select (WCS) experienced a significant discount compared to light sweet barrels in Houston due to competitive pressure from Euro barrels.
    • Crude oil is not a monolith and has different characteristics such as API gravity and sulfur content.
    • Higher API gravity means lighter crude, while heavier crude typically has more sulfur.
    • Sulfur is bad for prices as it increases refining costs.
    • Heavy sour crude has rallied $16 per barrel from Q4 to date, while light sweet barrels have traded flat to sideways.
    • OPEC cuts are bullish for heavy crude as they reduce supply and tighten differentials.
    • New refineries coming online are increasing the demand for heavy sour barrels.
    • The paper market saw a notable washout of a large hedge fund that was long on oil futures, indicating excessive long positions in the market.
    • The net speculative position in the oil futures market dropped to its lowest level since the opening of COVID, indicating reduced bullish sentiment.

    Speculator Positioning and Market Dynamics

    1:04:29 - 1:11:11

    • Speculators in the oil market are currently at their lowest net long position in a decade.
    • This is seen as a contrary indicator, suggesting that the next move is likely to be bullish.
    • The spec position affects the fair value of oil prices, which is based on inventory levels and supply-demand balances.
    • Currently, oil prices are below the fair value due to the short spec positioning.
    • If speculators shift from being very short to being very long, it could cause a sharp rally in oil prices, but this would be overextended and likely lead to a correction.
    • The shape of the futures curve has flattened out since September, indicating a less tight market.
    • The prompt spread, which measures the difference between the first and second month contracts, is sensitive to changes in market conditions and reflects sentiment.
    • Overall, while speculator positioning and curve shape provide insights into short-term market dynamics, fundamental factors such as supply-demand balance and Saudi Arabia's oil withholding have a more significant impact on prices.

    Backwardation and Inventory Levels

    1:10:56 - 1:17:39

    • WTI and Brent Curves re-entered full backwardation for the first time since May, which is fundamentally bullish but not super bullish.
    • A real breakaway in spreads and a decline in inventories are needed for flat prices to race higher.
    • US inventories are the most important to the market as they are visible and connected to the overall market.
    • The Strategic Petroleum Reserve (SPR) volumes are not a cumulative reflection of supply and demand conditions in the market.
    • SPR sales manifest as supply while SPR repurchases manifest as demand.
    • An SPR sale is bearish, and when it goes counter to the direction of prices, it indicates an incorrect interpretation.
    • Large moves in oil prices would likely occur if there is a protracted recession or if Saudi Arabia floods the market to reassert market share control.
    • Cautiously bullish short-term view with expectations of mid-to-high $80s for Brent in the second half of the year.

    Price Outlook and Economic Factors

    1:17:20 - 1:20:48

    • The price of oil is expected to push back up into the mid-80s in the second half of the year.
    • A crash in oil prices is more likely than a surge to $150 or $200 per barrel.
    • Recreating the conditions of the beginning of 2022 would be necessary for a mega bull case.
    • Increased supply of Iranian and Venezuelan barrels could take a million barrels a day off the market.
    • Policy choices rather than current trends are more likely to drive big upside moves in oil prices.
    • The downside risk is more likely to be economic calamity, while the base case is mildly higher prices.
    • The tails are more likely on the bearish side going into an election year.
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