Submitted by Bill Blain of Mint Partners
Blain's Morning Porridge: A Short Distraction In The Oil Market
Did I detect a distinct change in the market wind yesterday? There is a new freshening blow out the East. It feels like the world is changing: a slide in tech stocks and a wobble in sentiment, stronger oil prices and all the noise about Germany and where that leaves Europe, and Macron’s France’s dreams of Empire closer union.
Of course we still have all the usual worries, like North Korea saying Trumps twittering gives them carte blanche to shoot down American planes – which, to be honest, is unlikely because nobody is really that stupid… are they? And as Trump plays to red-neck sports fans, we also saw the death knell spike delivered on Obamacare reform. Then there is Spain vs Catalunya – perhaps a topic we should pay more attention to. And I think there was probably more news about Brexit, but to be honest I wasn’t paying attention and could not be ar**d to read about it. Bored of it. Get on with it.
As always, there is so much to think about.
Oil is one I’m watching closely because it’s the global commodity and market price that could change everything.
We’ve been arguing across the desk these past few years about whether $55-45 is the new normal range for oil, or do prices revert back towards $100? Some argue a stronger global economy means higher prices, others that the demand and supply dynamics have so fundamentally changed that a lower long term range is nailed-on for decades.
In this current rising oil phase – highest levels in over 2 years - prices have been driven higher on a number issues: concerns about Kurdistan supply (a whole can of worms in itself), OPEC generally sticking to cutting production, an uptick in anticipated demand from Asia and China in particular as it builds reserves, declining stockpiles, and the general sense the world is in recovery. That’s a long-term plus: as the global economy has “recovered” we’ve seen oil demand expand about 1.9%, while supply has lagged at 1.1% expansion. I’m seeing expressions like “rebalancing”, “turning a corner” and “price reversion” in the reports.
The fact China is supposedly building up strategic reserves as a hedge against future energy stocks is fascinating. But that’s a strategic rather than market issue. The FT reports one oil trader saying “China has helped to clean up the glut.”
Meanwhile, Bloomberg are looking to backwardation in the oil futures and predicting a potential scarcity of supply by 2019, quoting Citicorp reports on weak investment in new drilling. These sound like arguments for a higher long-term price – and all the implications that will have on global inflation.
But, the oil equation is a particularly interesting one in light of the “new-oil” revolution of the 2000s identifying new more efficient production methods and new sources – of which fracking, oil sands and shale were just part. The cost of oil has changed dramatically. In recent weeks we’ve seen US oil stocks back in vogue and a bright spot in stocks – they weathered the price crash, cut costs to the bone, and can now pump out as much oil as America needs at a far lower swing price.
Energy exports are underway – putting the US head-to-head with OPEC and its allies. The fact the US can profitably turn on the gas spigot whenever they like means they stand to benefit from any rally, and stem it. That puts the oil-funded spending junkies of OPEC at a chronic disadvantage. The old strategic oil imperatives change dramatically now the US is oil-independent and offering to supply core allies.
Of course there is always a rogue element in oil – for instance Iran, coming back on line after years of sanctions and able to produce at cheapest levels, while Saudi is so broke it just has to produce..
As a story, oil has further to run. The issue for markets is how dramatically will higher oil prices impact inflationary expectations in the current rosy Macro world-view? That could solve the lack of inflation at a stroke – but probably push stressed full employment economies like the UK into stagflation.