Crude Oil: In the past month, sentiment in the energy market has taken a U-turn which has resulted in the price of oil collapsing by over $20 per barrel, enduring the longest streak of sequential down-days in history (12 days). Echoes of “$100 oil in 2019” still rang when new narratives of “demand destruction due to trade wars” and “ineffective Iranian trade sanctions” began to take hold. Even one CNBC market commentator has proclaimed that oil could fall to as low as $40. The rate of change in sentiment has been truly incredible: how did the market swing from universal bullishness to the current level of bearishness in just over a month? How could the financial demand for oil fall so sharply while the physical demand continued to grow, remaining at its highest level in history? How could stocks basically flatline with oil rallying by 25 per cent from January to October and then get smashed by 30 to 50 per cent when oil fell?
From our observation, two major events led to the collapse in the oil price over the past month:
1. Ongoing trade war escalations by Trump increased fears of slowing global growth and with it concerns that oil demand growth was about to fall.
The U.S. issued Iranian import waivers to eight countries and this was perceived as a softening in Trump’s stance towards Iran. OPEC+Russia have already increased production by about 1.5 million barrels per day from the May 2018 lows, largely in anticipation of steep Iranian export declines. What happens if Iranian exports don’t fall as much as expected?
There’s also likely been forced unwinding by a U.S.-based commodity trading fund of a short-natural-gas/long-WTI trade and a notable increase in crude futures selling by financial houses that had hedged producers’ output. These factors have exacerbated the oil price fall, perhaps explaining as much as $10 of the $20 decline in crude. While fundamentals definitely loosened over the past several months, they can’t explain a $20 decline. Our sources tell us that Saudi Arabia now feels completely bamboozled by Trump and will champion a larger-than-expected production cut (1.4 million barrels per day or more) at the next OPEC meeting on Dec. 6. OPEC has recently said they will do “whatever it takes” to restore balance and we believe them. Our view that oil is in a multi-year bull market is unchanged. We believe WTI will average about $70 per barrel in 2019 and that it could trade to $100 more in 2020 based on the exhaustion of OPEC spare capacity and non-OPEC/U.S. production entering into a multi-year decline due to chronic underinvestment on long-lead projects.
On Canada, we believe that the combination of shut-ins (over 120,000 barrels per day), crude-by-rail ramping to 455,000 barrels per day by Q3/19, and Line 3 coming online by the end of 2019 will lead to WCS differentials falling to rail economics ($20 to $25 per barrel) by Q3/19. While Canadian light oil midcaps will struggle to attract investment versus Permian peers, Canadian heavy oil companies whose cash flow can double or triple based on a compressing WCS differential will attract fund flows and experience outsized returns.
Eric Nuttall on BNN.ca Market Call Friday Nov 16th @ 1200ET |
