Fragile Five or Shaky Six?

Readers may be beginning to think that we are a little obsessive about oil. However, while money may make the World go round, without oil the global economy would also come, literally, to a grinding halt. It pays to keep a close eye on what is happening in the oil markets, because surprises and “shocks” have a tendency to reoccur with some frequency, often as the result of a geo-political event or trend.

There is much debate about whether supply and demand for crude oil will be in balance in the near to medium term and perhaps maintain some sort of floor under the current pricing of both the Brent and WTI benchmark crude oil blends. One thing we know is that any forecast of oil prices is usually wrong because of all the factors which can influence that all important supply/demand balance.

One can enumerate a catalogue, including:

– US shale or “tight” oil production levels continuing to grow, and whether the US will become structurally a net exporter of crude oil
– The transition away from internal combustion powered vehicles
– Alternative energy sources, such as solar and wind
– The price levels petro-states need to balance their budgets
– OPEC’s (and its allies such as Russia’s) willingness and ability to enforce production level quotas
– Economic slowdown in the PRC and elsewhere
– Political crises in the Middle East and Persian Gulf

Geopolitics is always in the mix, which is where the Fragile Five and Shaky Six come in. The former comprises Angola, Iran, Libya, Nigeria and Venezuela. The latter adds Algeria, a surprise late-comer in the wake of the political disturbances set off by the supposed determination of the ailing Bouteflika to run for a fifth term as President (on behalf of Le Pouvoir, or Deep State) and then his abrupt withdrawal. Bear in mind that in 2017, these 6 countries exported some 8MM barrels per day, or just over 8% of global production according to ENI’s 2018 World Oil Outlook. While, the 6 may not all see significant reductions at once, Iran’s exports are being constrained by US sanctions; Nigeria is increasingly unstable; Libya is anarchic; and Venezuela’s PDVSA is in freefall. Stable they are not.

Yet, the US, in the guise of the EIA, apparently blithely still expects a global surplus through until the end of 2020- and the forward curve for WTI is essentially flat out to the end of 2020, if not in slight backwardation- presumably relying on growth forecasts for US shale oil production and increasing exports.

Such lack of expected volatility and “received wisdom” always makes us skeptical. Of course, life would be easier if the forecasts were accurate. Historically, the US could generally lean on key allies such as Saudi Arabia, to “do the right thing” and turn on the taps. However, that relationship is now dysfunctional (being polite) and the Saudis have a new (entirely self-interested and untrustworthy) “friend” in Russia, which is more than happy to be given the opportunity to administer another “poke in the eye” to the US’s perceived interests. This is compounded by the fact that the Saudis see themselves as in a potentially existential battle with the US shale oil industry over who is the “swing producer” and at what price levels. In fact, the shift in the US’ overall position from a net importer to a potential net exporter is already beginning to have “second order” effect in terms of its policy decisions affecting the Middle East, including the State of Israel. And, in the meantime, the opaque policy- and decision-making process in the PRC always has the potential for the unexpected.

At Awbury, we take the view that one should never assume stability and predictability in crude oil prices (or those of any other commodity, for that matter), and that it is essential to closely examine and stress any risk that involves a direct or indirect exposure, to ensure that one is not “negatively surprised” when volatility returns. To do otherwise would be remarkably naïve.

The Awbury Team

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