One for the History Books, a New Control Regime in Oil


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Thank you. LGM.

One has to give pause when you think that the only news in markets that mattered today is OPEC+ and what is their next move. We live in a world with growing oil demand and shrinking supply – the stakes are sky high. ESG matters, climate change, inflation, Iran, etc, mean nothing today in the global crude market. All people want to know is – what is OPEC+ going to do next? So clearly, IT is an important issue for the market before we tackle anything else. The sticking point in the talks – the UAE (United Arab Emirates) want a higher baseline after large-scale CAPEX investments in recent years’ production capacity and wants to boost production by 700mbd. On the other hand, the Saudis do not want to offend the Russians and other players by adjusting the UAE baseline.


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Gasoline, Summer Driving Season
After the U.S. handed far more control over the price of oil to the Saudis and Russians, consumers are paying the price. The White House wants this problem fixed by the time the 2022 midterm elections come around. Brent now up close to 116% since the eve of the 2020 U.S. Presidential election.

We are told OPEC+ is proud their “control of price” regime is back. A mere year ago, it was hard to grasp that they had any control after a 10-year hiatus as the dictator of pricing. We feel they canceled today’s planned meetíng just to save the pain of having to create more anxiety in the market when they admit OPEC+ could not land on a solution. Frankly, the agreement likely lies behind closed doors with a few parties and not the whole group. That is likely what is happening. But there are a bunch of people out there that say they have ‘inside contacts’ that likely know or think they know. “The deal we see is, no extension past April 2022, gives time for UAE to argue for a higher baseline, both are sides committed. Larry, there is a low probability of a destructive breakdown with a large boost in production, that´s not happening.” Energy Fund CIO in Canada, in our live Bear Traps, chat on the Bloomberg terminal.

The market hanging on the outcome of the weekend along with the meteoric rise of Saudi control of the market over the last year. All should be seen as a sign that they (OPEC+) don’t want to blow this opportunity. The March 2020 testosterone show inflicted a lot of pain on all sides, those scars are still healing. Oil price risk is to the upside. The likely UAE deal is a kick of the can to April 2022. The world is watching them again for signs of control or lack of it. OPEC lost control for 10 years when the Shale drilling spewed new non-OPEC supply into the market in ’09 and they don’t want to lose control like that again.

We are in a period of strong demand and weak supply. The UAE weekend proposal says no extension past April 2022, OPEC + wanted the extension for all of 2022. In recent months, years, the Saudis have worked many other members into contained quotas, baselines. A total breakdown is highly unlikely, “the oil market globally is in a sweet spot, there is too much money on the line for all the players. Demand globally is strong, we are looking at a deficit of 2.3 to 2.5mbd in June, the highest since last year coming out of covid” CIO, Pension Fund in Canada. If OPEC can’t make that perfect scenario work then it is sending a signal of significant weakness to the market. If they go down that disruptive road, volatility to pricing will be back. That is the last thing the Kingdom wants at this juncture. In other words, derivatives players will start controlling the price and we could see dramatic whipsaws in Brent – WTI as we did in the last decade prior to COVID rebalancing the market. While Saudi is in control, you won’t see the shorts show up. They have warned the speculators to stay away or be hurt. They listened for the most part but would show up again if this cartel were to start showing significant cracks. We just don’t think that OPEC+ is that unwise to let all of their great efforts go to waste over this quota issue. Demand surge is real, summer driving. Overall market dynamics best in decades, the risk to oil prices is to the upside. “All the emergency spare capacity is outside the USA now Larry.” Portfolio Manager in the U.S. Midwest. Spare capacity globally is mostly inside core OPEC, the ESG overdose has crushed US shale investments. “There is too much money in the hands of core OPEC, two years ago this was NOT the case with shale cranking” CIO, Macro Fund in NYC.

Further to that, there is an agreement that all parties are saying they are obligated to work with until Apr ’22. Even UAE says they are not trying to be a thorn or break up the cartel or even the agreement. So we think we can assume this agreement will be honored and we have relative stability until then. That is a lifetime in this market lately. Iran’s new supply risk is out in November in terms of getting oil to mkt, current shale new rigs coming online are not sufficient to impact prices near term. “Watch RIG equity as CAPEX investment start to come in, Q3. Very tight global market through year-end. One producer needs to produce 2.3mbd to get the mkt into a surplus, that is a high bar, not in anyone´s interest.” CIO Energy Fund in Canada.

US shale is not a threat as it is very high-cost production and requires higher prices or contango in the curve to see incremental supply enter the system. Also, the ESG (backfire) narrative still weighs heavy on their ability to grow. In this cycle, companies are being forced to return capital to shareholders. There is far less cowboy-up speculation, drilling. Frankly, this ‘noise’ around OPEC+ stability only shakes the ground under the US producer to remember how quickly prices could collapse again. After the colossal financial hit in Q1 – Q2 2020, shale speculators took their ball and went home.

The Curve is Telling
“It is time to think of the oil curve CL1 (front-month futures contract) is priced at $75.16 vs. CL36 (36 months out futures contract) down at $57.95. As you can see above the spread above is eye-opening looking back from 2005 to 2021. “Larry, the one-year backwardation roll is 11%, just wow” says a Veteran oil trader in our live chat. “Spikes in oil prices have triggered economic slowdowns historically. Remember, oil isn’t a forward-looking product. It is a ‘demand is here now’ product.. The curve shows it, CL36 at 2y highs vs. CL1 at 7y highs speaks volumes. WTI is saying this is a short-term supply and demand imbalance, Otherwise, PBR would be at $50/sh, its closer to $12.” Veteran Energy Sector portfolio manager, in Brazil.

Inventories are dropping and global demand is on the rise via economic re-opening, a massive increase in driving and massive unprecedented infrastructure spending around the world. We have yet to see the impact of global travel amongst countries via airlines which will add almost 3 mil b\d of demand. We don’t see any increase in OPEC+ production being considered as a threat to the current price. In this status quo market, we need more of their supply or we are going to see higher oil prices. The current situation is a very unique opportunity for OPEC to cash in. Non-OPEC – Ex USA production spare capacity around the world in decline. “We see strong demand (India, Europe) with real supply risk, it is not in OPEC´s interest to blow this opportunity.” CIO in London. Oil has a shot at $90 to $100 in, next 6 months.

We do not believe that a price-destructive “non-deal” is in the cards at this time. This is the strongest period OPEC+ has had in the market in decades and they don’t want to give that all up.