The flare-up in geopolitical tension at the beginning of the New Year prevented us from summing up the main market drivers of last year. Now that the US-Iranian conflict is de-escalating it is a good time to make up for this shortfall.
The most obvious observation one can make about 2019 is that risky assets were back in fashion. You will probably be surprised to learn that two of the best performers in the stock markets were Russia (+45% on the year) and Greece (+49%). Not that the rest disappointed. The MSCI Global Equity Index returned 24%. The S&P 500 Index jumped 29% whilst the DJIA yielded 22%. With all the uncertainty surrounding the UK leaving the European Union the FTSE 100 Index was somewhat sluggish as it only strengthened 12% but the German stock market matched the performance of the US with a jump of 25%.
In the oil market the star performer was RBOB with an annual return of 40%. WTI gained 32%, Brent 31%, Heating Oil and Gasoil both 21%, including roll-overs. WTI’s performance is all the more impressive given that this is the only contract the front-month spread of which averaged in contango over the year. Consequently, the energy sub-indexes of assorted commodity indices also had a good year. The Rogers Commodity Energy Index was up 23% in 2019 and the S&P GSCI energy sub-index returned 30%. Given the stellar performance of RBOB these indices would have produced more attractive results if the contract, which is usually undeservedly underrepresented, weighed more in any baskets. RBOB is by far the best performer of the past 13 years.
The main price drivers of 2019 were the US-China trade talks, US sanctions on Iran, non-OPEC and US oil production and OPEC’s reaction to the ever-increasing output levels from its competitors. The former two is the work of the US administration. No US President has had such a profound impact on the formation of equity and oil prices as Donald Trump. Actions, words, press briefings, tweets or just simple outbursts – the market reacted nervously and sometimes seemingly unjustifiably to every move he made. In a way the net impact of his influence was zero on oil. The harder he rocked the “trade balance” boat the more nervous the market became about global demand growth. On the other hand, his “maximum pressure” Iranian policy took off around 600,000 bpd of Iranian output of the market last year, which amounts to 1.7 mbpd over two years. We are of the view that one way or the other he will have to come to some kind or mutually acceptable trade agreement with China this year. The currency manipulator status of China has already been lifted yesterday. As for Iran, Mr Trump’s tough and ruthless approach is expected to prevail in 2020.
The trade war between the world’s two biggest economic powers has had a tangible impact on oil demand. The 2019 increase in global oil demand, that was forecast to stand at 1.50 mbpd back in July 2018 has been revised down to 890,000 bpd last month. This year, however, the pace is expected to pick up again and is to average at 1.25 mbpd, last month’s consensus figures imply. In case of a trade deal upward revisions can be anticipated.
For the second year running the increase in non-OPEC supply has outpaced the growth in global demand in 2019 and the trend is expected to continue in 2020. Last year non-OPEC supply grew by an average of 1.94 more, more than 1 mbpd over the global oil demand growth. The main culprit, you guessed right, is US oil production and within that US shale. The EIA puts last year’s non-OPEC supply growth at 2.06 mbpd. The US is responsible for 1.26 mbpd of it, all of which comes from shale. In 2019 US shale made up more than 70% of total US production, up from 67% in 2018 and 62% in 2017.
The same phenomenon will be experienced this year – non-OPEC supply will grow faster than global oil demand albeit the gap will narrow. The aforementioned 1.25 mbpd demand increase will be coupled with a 2.22 mpbd jump in non-OPEC supply. The gap is less than 1 mbpd compared to 1.05 mbpd in 2019. When OPEC’s other liquids are included in the equation the call on OPEC oil will “only” fall by 890,00 bpd in 2020, down from 1.08 mbpd last year and 1.98 mbpd from 2018.
There is no rest for the producer group and its allies and there is certainly no place for complacency. OPEC cut its production by almost 2 mbpd from 2018 to around 29.86 mbpd. The production discipline managed to prevent the market from falling out of bed last year but more hard work is needed for reasons mentioned above. The intention is seemingly there as demonstrated during the last OPEC+ meeting at the beginning of December. Another combined 500,000 bpd of output will be cut as the traditionally bearish 1Q gets underway. Unintentional supply cuts from the likes of Iran and Venezuela are likely to remain in place in coming months. What will be crucial as far as the credibility of the new supply deal and as a result market sentiment is concerned is the attitude of the undisciplined members of the organization. Strict quota adherence from Iraq and Nigeria will send out a strong message that the producer group can get through the first half of the year relatively unscathed. It will be well received by the market and no significant price erosion will be feared in the first half of the year before the tighter 2H kicks in.
The US is driving oil lower
The future looks brighter but the present is gloomy. The consolidation from last week’s spike above $70/bbl basis Brent continues. The market registered its fifth consecutive daily loss yesterday. Sellers have the upper hand despite stock markets are buoyed by the imminent signature of Phase 1 of the US-China trade deal. Yesterday’s weakness was undoubtedly driven by the US and within that by WTI and Heating Oil. The US crude benchmark lost almost $1/bbl to close at $58.08/bbl, the weakest settlement since the end of November. The front-month spread is now flirting with contango having been as high as +29 cents/bbl at the very end of last year.
Deteriorating margins force US refiners to cut back their runs denting demand for crude. Utilization rate fell 1.5% to 93% the week before last. It was 3.1% lower than a year ago and 1.1% below the 5-year average. This lack of enthusiasm should not come as a surprise given that the Heating Oil/WTI crack spread has fallen almost $3/bbl in little over two weeks. The bottom is probably not far but the immediate direction will be determined by tonight’s and tomorrow’s US inventory stats. The pattern of recent weeks is expected to continue. Analysts foresee a draw in crude oil and builds in product inventories. Any big surprise either way will serve as a basis for volatile trading in coming days.