Via BofAML's Jake Greenberg,
OIL: the battle for market share & the Saudi’s 1985 playbook
Stay positioned for “a good sweating” = stay short the SXEP (European Oil & Gas Stocks) and sell rallies
In 1985, the Saudis chose volume over price to defend their market share against new production from the North Sea, as well as cheating/discounting from other OPEC members in a period of weak demand. With Iraqi exports ramping up, in spite of the war with Iran, the Saudis went around the world signing netback deals, which incentivized refiners to buy/produce as much product as possible...the market was oversupplied and the price of oil fell from $31.72/bbl in November 1985 to $10.42/bbl at the end of March 1986. A fall of 69% in four months!
The Saudis had warned the world of their intentions, but many thought “it was merely an elaborate warning designed to scare other OPEC countries and restore discipline.”
See the chart below - the price remained volatile through 1986 and then saw a sustained recovery with the implementation of an OPEC quota system that members actually upheld until 1989. Interestingly, the agreement in 1986 also included cuts from non-OPEC members Mexico, Norway, and the Soviet Union.
In 1985-86, the Saudis gave the market “a good sweating”...WTI fell more than 69% in four months!
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The parallels with today’s market structure are hard to miss. US shale has replaced the North Sea as the new entrant to the market, ISIS has stepped in to create the geopolitical tension in place of Iran-Iraq, demand growth is falling, and the Saudi’s essential playbook remains the same:
I agree with the view put forward by Glencore’s head of oil this week that the price will stay low for at least 6-9 months without OPEC intervention, as it will take that time for cuts in capex and investment to make any impact. “The groundwork is being laid for a strong rebound in 12-18 months.”
How low can it go?
I spoke to an industry veteran in the US last week - who was in the market in 1985 - and he thought the absolute floor price would be $35/bbl, which he understood to be the cost to produce globally with positive cash flow, with no investment.
Interestingly, Bloomberg reported comments from Iran’s oil ministry’s head of petroleum market analysis who said this week that Brent could fall to $40/bbl if OPEC does not start to show some solidarity.
Francisco Blanch highlighted the risk that oil could fall to $50/bbl, and explained why we should not expect a decrease in supply, nor an increase in demand for c. 6 months.
Bottom line: Stay positioned for another “good sweating” = stay short the SXEP (European Oil & Gas Stocks) and sell rallies in 2015...
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