The outcome of the OPEC + Russia gathering in Doha was not an unpredictable outcome given the strategic momentum going into the meeting - continued conflict between Riyadh and Tehran.
It is true that there were many signals of potential cooperation, and one must forgive any analyst that listened to anything said or signaled by participants, including the Saudi's, prior to Prince Mohammed bin Salman's clear and resounding re-declaration that there could be no production freeze without Iran. The universal intention to walk away with some kind of nominal production freeze indeed seemed genuine.
Alas, diplomatic kumbaya fell victim to realpolitik, and no grand joint statement of cooperation was engendered.
Muted Oil Price Response
Considering that a production freeze was seemingly the higher probability outcome going into the weekend, the failure of the gathering should have sent oil prices lower.
Indeed, as seen in the price chart for WTI futures, oil gapped lower on Monday, reaching an intraday low of $37.61. But they have since bounced and currently sit just above $41.
While some have attributed the muted price action to the news flow surrounding the current strike in Kuwait, which has cut production by approximately 1.7 million barrels per day for the past three days, certainly any temporary political interruption is not that meaningful fundamentally in the context of the overall global crude oil inventory surplus.
Moreover, heading into the meeting, it appeared as though most speculative money was already betting on continued upward movement in oil prices. Thus, it is hard to attribute the muted price response to short-covering.
New Bull Market for Oil?
So should one conclude that oil prices are now poised to rocket up, now that the market is capable of shrugging off what normally would be considered bad news?
For guidance, we return to our roadmap to recovery, established in “Oil Prices - Price Discovery Spurs Widespread Declarations of Oilmageddon” (LinkedIn Pulse, 11 Feb 2016) and revisited last month in "Oil Prices - Fear Dissipates, Danger Lurks" (LinkedIn Pulse, 17 March 2016). The roadmap suggested that a majority of the four following signposts would be visible confirming the existence of a sustainable, long-term recovery in oil prices:
- Flattening Forward Curve - which is a prerequisite for the removal of economic incentive to store oil
- Evidence of Inventory Draws - visible proof of a change in supply/demand
- A major development in the Syrian War that enables the Saudi's to lead a production cut from OPEC
- Resolution of the China Growth Question, most likely expressed in the Renminbi exchange market
Last month, we concluded that none of these items was evident, and therefore, investing based on a sustained price rally in oil prices would be premature.
Today, we have seen meaningful improvement in the forward curves - but the overall market still exhibits a dominant contango structure (save the very front-month backwardation that has emerged in Brent). At most one could be constructive on the reduction in contango, but without widespread backwardation, the motivation for inventory reduction simply is not there.
Similarly, we are approaching the tailwind of seasonal demand draws, which together with the distortion of a pipeline shutdown from Canada, will reduce the headline risk of ever expanding inventories. But a seasonal shift in supply-demand is no more evidence of a change in fundamental supply-demand balance than a spring thaw is proof of global warming.
With respect to Syria, evidence that the Assad regime still has no intention of stepping aside despite the Russian motivation for an accelerated diplomatic solution are at complete odds with the notion of a reduction in Saudi-Iranian tensions. If anything, one might argue that Saudi frustration in the Syrian conflict might be what precipitated their seemingly undiplomatic approach to the Doha meeting.
China's recent statistics, which were modestly better, have perhaps delayed the immediate pressure on a revaluation of their currency. But again, to say that the Chinese growth question has been resolved is wide of the mark.
Confusion is the Father of Volatility
Thus, we remain as rudderless as we were a month ago. Yes, we see the anticipatory value of curtailed capital spending and falling production. But we don't see enough evidence of sustainable demand strength, or a coordinated OPEC production cut lead by the Saudi's to unconditionally embrace the notion of "up from here".
The price action post-Doha is not only confusing for investment professionals, but the Saudi royalty must be a bit disappointed as well. If oil prices are indeed their most powerful non-kinetic weapon, then the Doha outcome was a complete dud (at least in the short-term). While the Saudi political strategy may yet prove effective, a certain amount of damage has occurred to Saudi world voice, and several of their usual collaborators have been a bit put off. Nevertheless, we maintain that the Kingdom is much more of a mindset that they are fighting an existential battle. We can only hope that President Obama's visit rekindles some broader comfort.
In the meantime, confusion is the father of price volatility. On it's own, confusion only breeds paralysis, which may manifest itself in lower observed price volatility. But together with unexpected news flow, confusion drives erratic decision making, and price volatility expands as a consequence. Our most attractive investment positioning remains long crude oil volatility. We recommend oil producers and credit providers revisit their "hedging" strategy - the next couple of years are going to be quite interesting indeed.