Oil!

Brent crude rose near $90 a barrel on Tuesday.

Were it not for surging yields and obsessive pontificating about the trajectory of Fed tightening, crude would’ve been the story.

Prices are the highest in seven years (figure below). Oil’s up double-digits in 2022 already. A deadly Houthi drone attack targeting fuel tankers in the United Arab Emirates added some geopolitical seasoning to an already spicy mix. At ~$85, WTI is a long way from negative $36.

The Houthi “problem” isn’t new. Wars of attrition are unwinnable almost by definition, and the Houthis are the worst kind of antagonist — they’re state-backed, but enjoy more operational independence than Iran’s other regional proxies.

While the assassination of Qassem Soleimani appeared to debilitate (or, at the least, degrade) the capabilities of Tehran’s militias in Iraq, Houthi mischief never relented. Earlier this month, on the two-year anniversary of Soleimani’s death-by-Reaper, they seized a UAE-flagged ship on the excuse it was ferrying weapons. The Saudis called it “armed piracy.” In 2019, the group took credit for a historic attack on the Kingdom’s oil infrastructure, a brazen endeavor that had Soleimani’s fingerprints all over it.

The conflict in Yemen is almost as absurd as it is tragic. And that’s really saying something. Because it’s pretty damn tragic. Yemen is home to (arguably) the world’s worst humanitarian crisis. A half-dozen years in, the Saudi-led coalition still won’t admit to the futility of it all. Ever-shifting alliances and a dizzying hodgepodge of combatants long ago rendered conflict analysis impossible. Weapons sales make the US complicit in untold suffering.

Jake Sullivan condemned Monday’s drone attacks and promised to hold the Houthis accountable. It’s not even clear what that means, other than handing out more sophisticated weapons to the coalition. Plainly, 20 years in Afghanistan wasn’t enough to convince Washington that overwhelming military supremacy is insufficient to prevail in unconventional warfare. Mohammed bin Salman is never going to win a decisive victory in Yemen, but unlike leaders in (nominal) democracies, he doesn’t have to worry about public opinion.

In any event, the geopolitical premium waxes and wanes in crude, but it’s always there. The Mideast isn’t exactly known for stability. To the extent any additional price gains are attributable to tensions with the Houthis, that premium will likely come off at some point, especially if there’s diplomatic progress on the nuclear deal (not a foregone conclusion).

Late Monday, Goldman upped their price targets. The bank now sees spot Brent running to $105 in 2023 and $96 this year (table below).

The bank emphasized that they’re “not forecasting Brent trading above $100/bbl on an argument of running out of oil.” “Unlike in the late 2000s, the shale resources is large enough to help rebalance the oil market, albeit at higher prices,” Damien Courvalin wrote, adding that “this mechanism will, however, likely require ever rising oil prices given the reluctance to invest in oil during the energy transition and the gradual depletion of shale’s geological, midstream and service capacities.”

The full note is a laborious exercise, admirable for the amount of time invested, if nothing else. It’s 34 pages long, and as such isn’t amenable (at all) to summary treatment. Mercifully, Courvalin managed to extract a summary. By summer, OECD inventories will reach their lowest level in two decades “alongside a decline in OPEC+ spare capacity to historically low levels of c.1.2 mb/d,” he wrote, adding that,

At $85/bbl, the market would remain at such critical levels, insufficient buffers relative to demand and supply volatilities, through 2023. As the six precedents since 1990 invariably show, consumers attempting to secure physical supply will first drive backwardation steeper, at which point the unwind of producer hedges and consumer forward buying will lead long-dated prices higher, normalizing inventories and spare capacity through the combination of demand destruction and higher supply. We believe the market needs to solve for this once again, with the prospect of long-term shortages leading to near-term surpluses. At our updated demand and supply elasticities, we model this rebalancing will require long-dated prices rising to $90/bbl, bringing our Brent spot forecast to $105/bbl in 2023 (with 2022 at $96/bbl). At such prices, we estimate that the rebalancing will be achieved through 0.6 mb/d of demand reduction, although to still record high and above consensus levels, with shale growing 0.8 mb/d YoY in 2023.

The vagaries of the oil market mean these forecasts are subject to change, but suffice to say the sheer scope of Goldman’s latest “update” makes it difficult to offer much in the way of pushback unless you’re prepared to engage in a tedious debate around a laundry list of somewhat esoteric dynamics.

One passage that’s straightforward enough, though, found Goldman noting that “oil prices have fully reversed their post Thanksgiving melt-down” as “robust fundamentals” rapidly triumphed over “a wall of worries that failed to materialize,” including the Biden administration’s SPR release, Omicron and concerns around OPEC.

Although the hit to demand will be “large” for China given the Party’s “zero COVID” strategy, Courvalin wrote that outside of China, the Omicron hit “to on-road and jet demand appears smaller than that of Delta [and] will end up offset” by a slew of factors, including, but not limited to, upside surprises in demand, ongoing gas-to-oil switching and increased supply disruptions.”