The noises coming out of Washington have been very confusing lately. A bigger than normal dose of uncertainty surrounds the trade policy of the US administration. It all started last Friday when President Trump demonstrated its support for the Hong Kong protesters. This week he raised the possibility of not striking any deal with China until after the 2020 elections and threatened to put tariffs on France (digital tax) and other EU countries (Airbus subsidies). This rhetoric resulted in a 2.5% fall over three days in the S&P 500 index. Equities corrected higher yesterday as the US-China trade deal is reportedly edging closer, according to a Bloomberg tweet. Trump now says that talks are going “very well”. Go figure. Nevertheless equity price movements in the first half of the week showed what investors think of protracted trade tensions. It is simply hard to believe that the misleading signals from Mr Trump are anything but attempts to gain leverage in trade negotiations.
The renewed hopes for a trade deal were one of the three ingredients of the bullish cocktail we were served yesterday. Stock markets edged higher and oil went with it. The barman also put additional spice in our drink in the form of this week’s OPEC+ gathering. There have been hints and suggestions that the producer group can actually go for a deeper cut – maybe an extra 400,000 bpd. There is not much more to say about the possible outcome as ministers are gathering in the OPEC headquarter in Vienna other than the current mood is upbeat.
Finally, the EIA also played its part in yesterday’s rally. Despite the more than 3 million bbls builds in both distillate and gasoline stocks commercial inventories fell by close to 5 million bbls. This was due to the 4.9 million bbls drawdown in crude oil stocks and the 6.5 million bbls depletion in the “other product” category. Both crude markers settled over $2/bbl higher and the main product contracts gained over 400 points on the day. The market has managed to recover completely from Friday’s slump and the next push, either up or down, will come from Helferstorferstrasse 17, in Vienna.
Bulls will be helped by the structure in 2020
We implied in Monday’s report that the energy complex is likely to have a good year. It can even be described a brilliant one when you compare it with 2018. Last year looked very encouraging, indeed too but the performance in the last quarter neatly wiped out the profits that had been made in the preceding nine months. It is certain that the price fall one year ago will be brought up today and tomorrow in Vienna. OPEC overdelivered on its commit- ment in the first half of 2018 and reached a conformity level of 152% by April. In June the organization and its non-OPEC peers made a U-turn and agreed to bring compliance down to 100% – partly due to increasing pressure from the US. Consequently WTI lost 17% in 2018 and Brent fell 15% (including rollovers) as OPEC production jumped to 32.76 mbpd by September 2018 (also helped by growing demand concerns because of the trade war). In the words of the Greek philosopher Heraclitus “no man ever steps in the same river twice”. The OPEC+ group is unlikely to go down the same road this time around.
This year the underlying picture is much brighter despite non-OPEC supply growth outpacing global oil demand increase. The OPEC call is nearly 890,000 bpd below that of 2018. Yet year-to-the-end-of-November all the major futures contracts are posting decent returns. Brent and RBOB are the star performers with returns of 27% and 36% respectively. The year has been characterized by a $25/bbl rally in the first four months followed by a fall of $19/bbl between May and August and some kind of consolidation since then. The first third of the year received a boost from the OPEC+ group that showed a respectable discipline in sticking to the new production quota that was agreed last December. The US refusal of renewing Iranian sanction waivers also helped. Economic concerns from May onwards triggered some profit-taking and the market has been torn between high OPEC+ compliance and growing nervousness about US trade policy over the past 2-3 months.
Despite OECD inventories rising this year oil prices are higher. It suggests a market that is generally positive or bullish. This underlying optimism is also confirmed by the front-end structure of the five main oil futures contracts. With the exception of WTI all front-month spreads have averaged in backwardation this year – some more than the others. The nature of the front-end structure has added more than 10% to the return of Brent and 16% to the annual gains in the RBOB contract. The role of the structure was less significant in Heating Oil and Gasoil. It contributed less than 1% to the return of the former and slightly more than 1% to the latter. WTI that showed the biggest profit on a gross basis was knocked down to third place when rollovers are taken into account. The negative role of rising domestic production is unquestionable although it is worth pointing out that the US benchmark is trying hard to stay in backwardation in the past 3-4 months.
If backwardation is a sign of some kind of physical tightness then what to expect for 2020? Every single futures contract is displaying backwardation 12 months out. As of last night’s settlement it is $4.10/bbl on WTI, $4.34/bbl on Brent, 454 points on Heating Oil, 875 points on RBOB and $19.75/tonne on Gasoil. These are not outrageously deep curves nevertheless do not imply fears of oversupply either and could serve as an incentive for money managers to increase length and make extra profit on rollovers.