US traders had clearly thought long and hard about the oil market on Thanksgiving and concluded that prices are unjustifiably high, maybe due to the rising tension between the US and China because of the Hong Kong protests. Or they might have been disappointed with the lack of real upside progress on Thursday and Friday morning and decided to shed substantial length as the month was drawing to an end. The slump was led by RBOB that lost more than $3/bbl equivalent on the day and WTI and Brent were down slightly less than $3/bbl.
Despite the massive sell-off on Friday risky assets had a relatively good month. Each of the five main futures contracts produced positive returns whilst the main stock indices have also finished November stronger. Barring any unexpected developments during the last month of the year the whole of 2019 will be viewed as a positive one. Year-to-date WTI is up 19%, Brent has gained 21% and the MSCI Global Equity Index has, so far, returned 20%. It has been a complete turn-around from last year when the European crude marker, for example, lost 15% of its value.
As a matter of fact December can provide answers to quite a few questions as what to expect in 2020. The latest Reuters price poll implies that analysts are sceptical about a sustained rally next year. Brent that has averaged just above $64/bbl this year is forecast to weaken somewhat in 2020 to $62.50/bbl, only a tad above last month’s prediction of $62.38/bbl. The current 2020 Brent curve is around $59/bbl. The reason for this downbeat view is well publicized. Sluggish economic growth coupled with rising non-OPEC production will lead to an oversupplied market unless it is properly managed by global swing producers. Given that this month’s OPEC and its ten non-OPEC peers will meet, the UK will vote in the next parliamentary elections and the US must decide by the middle of the month whether to impose further tariffs on Chinese goods it is fair to say that the tone will shortly be set for 2020. These events coupled with US production growth estimates are the most important factors to watch out for in coming weeks and months.
The latest projections do paint a gloomy picture for next year, especially for 1H 2020. OPEC sees the demand for its oil at 29 mbpd for the first half, down from 30.15 mbpd during the same period of this year. It is a challenge to balance the market where demand growth is outpaced by non-OPEC supply growth but the organization does not really have a choice. Bloomberg reports that Saudi Arabia is becoming increasingly frustrated with the lack of compliance and will certainly raise the issue at the end of this week in Vienna. At this stage it is not clear what the kingdom wants to achieve but given that the shares of Aramco will start trading on the local Tadawul exchange a week after the OPEC meeting it is unlikely that the Saudis would rock the boat 2014-style.
Instead, the current production level is likely to be rolled over with extra pressure on those who produce over their ceiling. On Friday the Russian energy minister said his country would prefer to decide on the extension closer to the end of the first quarter. As the current deal runs out by the end of March the practical impact of the request, if granted, is negligible. The bottom line is that the OPEC+ group has to survive the upcoming six months unhurt after which the second half of the year will look brighter. Any sign of discontent between the producers will send out negative signals and will put significant downward pressure on oil price. We believe this is unlikely to happen.
Non-OPEC production and within that US shale output acts as a brake on any oil rice rally. The EIA is very optimistic on domestic production growth. It believes that US output will reach 13.29 mbpd next year, up 1 mbpd on 2019. This figure will make any oil bull disheartened. It is, however, worthwhile noting that US production growth is 100% made up by the increase in shale production. In 2017 the average monthly growth rate was 115,000 bpd and in 2018 it stood at 140,000 bpd. This year, however, it has fallen back to 74,000 bpd as investors are pushing shale companies to produce some returns on their investment. Next year’s predicted US output growth may turn out overestimated.
The demand side of the equation is equally important. Global and regional GDP growth estimates have been constantly revised downwards as manufacturing and service sectors, consumer spending and sentiment have all been negatively affected by the protracted trade disputes between the US and other countries, amongst them China. Talks have been ongoing for a few weeks to come to an agreement on a preliminary trade deal between the two nations. This progress suffered a serious set-back last week as the US openly demonstrated its support for the Hong Kong protesters to the annoyance of China. If no deal is achieved in the next two weeks further import tariffs could be implemented on Chinese goods worth $156 billion by December 15. This will trigger a rush out of risky assets into safe havens. Even if it happens it is hard to believe that the US will play hardball with China next year as the 2020 election campaign is getting into full swing.
In the UK we will know by the end of next week who will be able to form the UK’s new government. If polls are anything to by (they have been notoriously unreliable in the past) the Conservative party is expected to be the clear winner – although its approval ratings have fallen after last Friday’s shocking attack at London Bridge. The UK, therefore, is likely to leave the EU by January 31. A very hard Brexit is still very much a possibility, nevertheless a great amount of uncertainty will be removed by early next year with the potential negative impact of the EU-UK trade talks only to be felt later on.
The view here is that the consensus on next year’s oil price is conservative. OPEC+ discipline, less-than-expected US oil production growth and an eventual trade deal ought to provide some decent price support, especially in the second half next year. These are the strings that are attached to our bullish view. Once again, by the middle of this month we will have a better picture whether our optimism going into 2020 is justified or not but currently we would bet on an average 2020 Brent price that is much closer to $70/bbl than to $60/bbl.