It’s a holiday weekend for U.S. investors, which means those of you who aren’t, like me, hindered in your capacity to imbibe by a near-death scotch experience, are probably at least halfway to the bottom of a bottle of something and thus not pondering the potential ramifications of Friday’s news from Khalid Al-Falih, who sent oil prices tumbling the most in a year with comments about boosting output to ease the pain on consumers from the heretofore relentless rise in crude prices.
The knee-jerk reaction was rather dramatic, with futures down the most since July 5:
Whether the shift in the Saudis’ reaction function was informed solely by one Trump tweet (as reported) is obviously debatable and in the post linked above, I tried to put a little meat on the proverbial bone in terms of geopolitics and regional strife. But my take was hardly exhaustive; this is an inherently complex and opaque calculus, complicated immeasurably by competing geopolitical agendas and affected by wild cards like the situation in Venezuela.
All we know for sure is that there seems to be a will on the part of Riyadh to put the brakes on the rally and for markets, the motivation isn’t really material in the very near-term (obviously the rationale is highly relevant over the medium to long-term, but effectively trying to trade against Al-Falih in the short-term could prove to be a rather precarious endeavor so you know, sell first and reassess after the weekend).
Well for anyone paying attention on Saturday, Novak was on the tape. Here’s Reuters:
A return to the oil production levels that were in place in October 2016, baseline for the current deal to cut output, is one of the options for easing curbs, Russia’s energy minister said on Saturday.
Sources said this week that Saudi Arabia and Russia were discussing raising OPEC and non-OPEC oil production to ease 17 months of strict supply curbs amid concerns that a price rally has gone too far.
“When we extended the agreement until the end of 2018, we spoke about such possibilities (of returning to the October 2016 level),” Novak told reporters.
“But a decision will be made in June,” he added, referring to meetings of OPEC and non-OPEC countries in Vienna on June 22-23.
You can take that for what it’s worth (or isn’t worth), and you should probably try and incorporate into your assessment the impact of U.S. sanctions on the ruble’s link to crude and what that means for Russia’s cooperation with the Saudis (see here and then adapt the analysis to fit Friday’s developments), but a straightforward look at the situation informed by historical precent suggests oil is still likely to remain buoyant in the medium term irrespective of any near term weakness.
Or at least that’s Goldman’s story.
“We do not view this as a bearish development,” the bank writes, of Friday’s news. Here, in brief, is their rationale:
While [Friday’s] announcement lifts some of the uncertainty on whether and when OPEC and Russia would increase production, we do not view this as a material change to our bullish oil outlook: (1) this response is occurring because of a tight oil market, (2) its magnitude is still uncertain but, even at 1 mb/d, such an increase would simply offset the involuntary production declines with the group still committed to restraining output, (3) even at 1 mb/d, its gradual implementation would leave the market in deficit through 3Q18
(4) ongoing disruptions in Venezuela and potential losses from Iran are likely to partially offset this higher supply,
as well as (5) require further increases in production in 2019, which will further reduce already limited spare capacity next year.
To the extent all of that is debatable (i.e., to the extent you’re inclined to disagree with any of it), then the more compelling argument for why Friday’s news isn’t a precursor to sharply lower prices is that, to quote Goldman one more time, “history shows that increases in OPEC production quotas in a strong demand environment (like today) are followed by higher prices in the subsequent months.” Here are the visuals on that:
So if you’re newly bearish following Friday’s plunge, then I suppose the simplest counterargument to your position is that history isn’t on your side.
Food for thought.
One thought on “Why Friday’s OPEC News Isn’t Actually Bearish For Oil, According To Goldman”