When the market makes a relatively significant move without any obvious or tangible reason, it is always convenient to conclude that the price action was technical-driven. Probably this is what happened yesterday as both WTI and Brent shied away from last Friday’s high and ultimately finished the day in the red. It is tempting to use the latest Drilling Activity Report from the EIA for the weakness. It showed that US shale production will reach 9.1 mbpd in December, up 48,000 bpd on the month, however, by the time the estimate hit the screens most of the damage had already been done.
Apart from the shale forecast there was no fundamental reason for oil prices to fall. Firstly, stock markets edged higher again as optimism about the US-Chinese trade deal persists (although no fresh progress was reported yesterday). Secondly, Iran is scaling back on its nuclear commitment and people are taking to the streets due to the weekend’s rise in domestic petrol prices. Social unrest also intensifies in Iraq and protesters have blocked a domestic port. Thirdly, according to the Saudi-led coalition Houthi rebels have allegedly hijacked a vessel towing a South Korean drilling rig in the Red Sea. There is no better way to put it, the geopolitical tension is rising in the Middle East again. The structure of the two main crude oil futures contract is holding up well and the rise to 11.25 mbpd in Russian November crude oil production is only marginally higher than last month. Based on yesterday’s developments there is no fundamental justification to predict protracted or meaningful weakness in the oil market.
Financial investors are getting hungry again
The tentative optimism described in yesterday’s note is confirmed by the recent action of money managers. Net speculative length (NSL) in the two main crude oil futures contracts is rising. The weekly increases were 40 million bbls in WTI and 28 million bbls in Brent. The jump from the recent bottom a month ago has been a very respectful 174 million bbls combined. Over the past four weeks speculators have pumped more than $9.5 billion into the crude oil futures contracts. There is now $28.9 billion committed in these assets compared to $17.4 billion for the week ending October 15. In WTI the increase in NSL over the past four weeks was more down to shorts covering (43 million bbls) than longs adding to their exposure (23 million bbls). In Brent bulls have not been faint-hearted: they increased their gross length by 85 million bbls whilst reducing short positions by 23 million bbls. Gross long positions are still some way below the year’s highs in both contracts: it is currently 254 million bbls in WTI versus the 2019 high of 370 million bbls. The same figures for Brent are 380 million bbls compared to 434 million bbls back in April.
A trade deal is quietly struck
By now it is almost an axiom that in case of a US-China trade agreement risky assets will get a boost because regional and global economic growth prospects will improve significantly. Manufacturing and service sectors would turn positive, customer spending would grow, and investments would start rising again. That is because trade agreements are deemed supportive for economies and as such for oil demand and oil demand growth.
If that is the case, then recent developments are certainly pleasing for the advocates of free trade and globalization. Whilst the bilateral trade policies of the US administration are undoubtedly acting as a break on global growth, it appears that there is life outside the US.
At the beginning of November 15 countries agreed on plans to launch the world’s biggest trade deal called the Regional Comprehensive Economic Partnership (RCEP). The idea is to ratify the agreement next year and gradually free up trade between member countries – these are the ten ASEAN countries together with China, Japan, South Korea, Australian and New Zealand. The participating nations make up almost one-third of the world’s population and the third of global GDP. Had India not pulled out this month almost half of the global population would be impacted by the deal.
The RCEP started seven years ago as an attempt to harmonize agreements between member countries of the Association of Southeast Asian Nations. These talks then were turned into a broader co-operation with the aim of strengthening trading relationships between participating nations. The broad objective is to lower tariffs and trading barriers among the fifteen nations.
As mentioned above India was expected to participate, too but decided to put its interest on hold this month. The decision came as India wants to protect its service workers and farmers and because of concerns that China would flood the world’s second most populous country with cheap products. Agricultural produce from New Zealand and Australia would also harm Indian farmers. China, however, rushed to assure India that it is welcome to join the RCEP whenever it thinks it is suitable.
The exact terms of the trade agreement are not entirely clear, but the basic idea is to gradually lower tariffs and trading barriers between participating countries. It will allow companies to export the same product in the bloc without filling out separate paperwork. It incentivizes companies to build up supply chains and it also touches on services and protecting intellectual property.
The RCEP is not as “high quality” as the Trans-Pacific Partnership (TPP) was before the US decided to leave it or the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) that was grown out of the former TPP as it covers much less ground. The RCEP, for example, does not require members to liberalize their economies, protect labour rights and does not cover environmental issues. On the other hand, it will be, when it is signed, the biggest trade pact in the world that aims make trade flow as seamless as possible and as such goes against the current trade policy of bi-lateral trade deals of the US administration. Let us stress that it is launched in Asia, the engine room of global oil demand growth.