Beyond OPEC: Oil Markets Have Serious Demand Issues

The key theme driving oil prices through the beginning of this week was cooperation. On the OPEC+ front, we've had cooperation between MBS and Putin resulting in a 9-month production cut into March of 2020. On the trade front, we've had cooperation between Trump and Xi which prevented further tariffs from kicking in, saw both sides give key trade concessions and set the table for a return to real negotiations. Both events gave crude oil a positive push and moved Brent over $66 for the first time since May. Unfortunately, we think traders might be wise to apply some skepticism to both fronts. While geopolitical dealings may look rosy at the moment, cooperation within OPEC+ and between US/China is still climbing an uphill slope. The skepticism should be compounded by stark reminders mid-week that the global economy may be slowing and sent Brent back below $63.

On the OPEC+ side, markets had already priced in an extension of existing supply cuts into 2020. The tricky part in judging the Russia/Saudi relationship will be that diverging oil budgetary needs could undermine the ability of the two nations to cooperate over a long period. For the near term, this concern has been put to bed by this week's OPEC+ deal which OPEC Secretary-General Mohammad Barkindo referred to as a marriage which would last into eternity. The signatories of the new deal even exchanged poems and gave each other pins to commemorate their accord. Russia/Saudi oil market cooperation will enter its fourth year in 2020 for an impressive run which- despite failing to sustainably deliver the $80 oil prices the Saudis would like to see- has been successful in preventing a return to the $27 mark which almost bankrupted several major oil exporters in January of 2016.

While the deal is obviously supportive for prices in the near term, we were struck by its announcement and messaging, specifically the decision by Russian President Vladimir Putin to casually proclaim to reporters that he'd decided to extend the deal after an informal meeting with MBS over the weekend (about 48 hours prior to the formal announcement.) We view this behavior by Putin as a clear shot across the bow that he'll be the one calling the shots on future OPEC+ coordination which may could mean a break down in 2020 given that Russia has reportedly been upset about losing oil market share to the US and only needs $45 crude to balance their budget. We think traders should view an extension in 2020 as far from certain and this could transmit bearish risk into oil prices as early as 4Q'19.

As for Trump/Xi, the recent G20 in Japan provided the two leaders with an opportunity to rekindle trade negotiations and both sides seemed eager to return to the table. As always, we like monitoring the market's view of US/China progress via stocks and this week saw the S&P 500 reach a new all-time high while the Shanghai Composite is up 6% in just the last three weeks (but still about 14% below its YTD high in April.) Traders clearly see signals that progress towards a deal is being made but we wouldn't bet the farm on a deal just yet. We've previously thought that Trump would be eager to make a deal that he could boast about on the 2020 campaign trail, but his willingness to leave negotiations in May was a sharp reminder that trying to predict Mr. Trump's actions can be very bad business.

While cooperation seemed like the name of the game this week, let's agree to be far from certain that OPEC+ and Trump/Xi will be able to keep the romance alive. To get even more negative, the need for OPEC+ to continue managing the market- which was supposed to be a short-term fling rather than a marriage- 3.5 years later is a not so tacit acknowledgment that the market has serious demand issues. Genuine economic strength- not just love and cooperation- is what the bulls really need.

Quick Hits

- Brent crude rose sharply at the end of last week and beginning of this week topping $66 on hopes that OPEC+ and Trump/Xi cooperation would take the market to new heights. Instead, the pact seemed to remind everyone that oil markets are suffering from anemic demand and prices eventually dipped back below $63.

- Bank of England Governor Mark Carney added to macro downside concerns in a speech on Tuesday which cited increased political protectionism, tariffs and a looming global economic slowdown which may require a major policy response from the world's central bankers.

- On a more bullish note, Bloomberg's estimates for OPEC's productivity in June are out and we found the results to be surprisingly tight. For starters, Iranian exports were driven down to just 296k bpd in June. After seeing dozens of Iranian tankers doing business in the Persian Gulf and Asia in the last few weeks, we were surprised to see this low number which strongly suggests the Trump administration's recent sanctions efforts have been effective.

- Saudi Arabia's production also surprised us to the low side coming in at 9.73m bpd which is down 1.34m bpd since November. OPEC's total group production was estimated at 30.0m bpd representing a 130k bpd drop m/m and a decline of 3.15m bpd in the last seven months- a bullish effort indeed! And one that points to just how sick the demand of the market is given that OPEC's continued discipline can't seem to jolt prices sustainably into the $70s.

- Saudi leadership is said to be back to exploring a partial IPO of Aramco in yet another sign of Saudi financial stress.

- Brent spreads were clobbered this week in another sign that traders see weakening market fundamentals ahead. The month 1 v. month 2 Brent spread is currently trading at just 24 cents backwardated, down from 70 cents backwardated on June 6th.

- Somehow equity markets were immune to the macro stress seen by oil markets this week. The S&P 500 touched a new record high of 2,981 on Monday while the EURO STOXX 50 was back at its 2019 high of 3,500.

DOE Wrap Up

- US crude inventories fell by 12.8m bbls last week driven by a massive shift in trade flows. Unfortunately, crude stocks are still higher y/y by 12% over the last four-week period.

- US crude production fell by about 100k bpd last week to fall to a 6-week low of 12.1m bpd.

- US refiner demand had a decent uptick last week to 17.3m bpd but its 4-week moving average of 17.15m bpd is lower y/y by a jaw-dropping 450k bpd.

- Crude inventories in the Cushing delivery hub dell by 1.75m bbls last week to 51.8m.

- The US currently has 27.4 days of crude oil supply on hand which is about 1.0 day above its seasonal 5yr average.

- On a more bullish note, the US currently has 21.6 days of gasoline supply on hand which is its lowest mark in more than five years.

- As we mentioned, the large driver of last week's drop in crude stocks was a massive drop in imports opposite a good jump in exports. US traders shipped 6.7m bpd of crude into the US last week for a weekly decline of about 800k bpd while exports jumped 350k bpd from 3.42m bpd to 3.77m bpd. Net crude imports, therefore, printed near 2.9m bpd for its second-lowest total in the last twelve months. For some perspective, the US has had net imports of roughly 4.2m bpd so far in 2019.

- US gasoline inventories fell 1m bbls last week to 232m and are lower y/y/ by 2% over the last four-week period.

- Distillate stocks fell by about 2.45m bbls last week to 125.4 and are higher y/y by about 10% over the last four-week period.