Dear colleagues. The fall of oil quotes into the negative zone caused a serious commotion not only on world exchanges and the information space, but also in the minds of investors. What until recently was unbelievable has become a reality. However, negative prices cannot be the norm, and on the eve of the car season, oil experienced a rapid recovery and now has good chances to gain a foothold at current values and possibly increase.
Saudi Arabia, which decided to fight on two fronts, suffered a crushing defeat. Initially, it was believed that Russia had declared a price war to the whole world, having decided to withdraw from the OPEC+ deal, but the actions of the Saudis aimed at squeezing out the Russian market share in Europe and at the same time squeezing American shale producers on their territory enraged the executive and US legislature. Crown Prince Muhammad bin Salman, who had previously had a lot of things to do, fell out of favor with the Donald Trump administration, who threatened the Royal House of Saudi with refusal of military support and other punishments, up to the arrest of accounts and property. Thus, the agreement between the US and Saudi Arabia, concluded back in the distant 45th year of the last century, ceased to exist.
At the end of World War II, U.S. President Franklin Delano Roosevelt and King of Saudi Arabia Abdel Aziz entered into an agreement assuming that the United States would receive the necessary amount of oil, guaranteeing the security of the Saudi ruling house in return. However, the kingdom violated this treaty at least three times, which happened in 1973, 2016 and 2020.
In 1973, during the Arab-Israeli war of Yom Kippur, the Saudis put pressure on OPEC members and the countries that joined them to impose an embargo on oil supplies to the United States, Britain, Japan, Canada and the Netherlands. Then, by March 1974, the price of oil had quadrupled, rising from $3 to $12 per barrel, and despite the truce that followed, seeds of distrust between the allies were sown, which did not prevent them from actively cooperating. Since then, the United States has dreamed of getting rid of energy dependence, and when the American shale industry began working with natural gas in 2006, they got a window of opportunity that they took advantage of.
In 2010, the development of oil sands began, which by the end of the decade made the United States a world leader in producing oil and liquefied gas, in a relatively short time, turning the country from an importer to an exporter of energy resources. Thanks to daily oil production of 13.5 million barrels, the United States took first place in the world in production, most of which, namely 60-70%, accounted for shale producers.
Having freed itself from oil dependence, America finally got the opportunity to impose sanctions against objectionable oil producing countries such as Iran and Venezuela, without fearing for its own energy security. Given this geopolitical component, we can safely assume that, having a printing press at its disposal, the United States will never capitulate to oil quotes in a war. Therefore, it is not surprising that the actions of Crown Prince Salman, who was encroaching on the holy, caused the wrath of the US establishment, and the main culprit of the oil crash was the country's royal house-gas stations.
However, the Saudis, as they say, bit the bit. The Saudi sheikhs did not understand or perhaps did not take seriously the warnings coming from Washington. In early April, they sent an armada of oil tankers to the United States, which was perceived by the White House as a direct threat to the US economy and security, while the country struggled with the COVID-19 epidemic. The US shale industry was too important to be ruined.
US politicians simply cannot allow OPEC to manipulate oil prices, which are critical for the kingdom. According to some reports, the price of oil required by Saudi Arabia to fulfill budgetary obligations is at least $84 per barrel, while Russia needs $42. The problem of the Saudis is that they also started a price war in the year of the presidential election, when the US administration faces a dilemma: where, on the one hand, the shale industry, which provides up to 10% of GDP, and on the other hand, US consumer spending. Where every cent of the gallon of fuel costs takes $1 billion out of citizens' pockets. Thus, the Trump administration cannot allow an increase in oil prices above $70, but nobody is going to bankrupt the shale industry to please the Saudi sheikhs either.
At the most difficult moment, as usual, speculators came to the aid of oil prices, read - private investors. Even before the price of WTI oil became negative, ordinary citizens of the country began to invest in the United States Oil - USO stock exchange fund, which is one of the main holders of futures contracts on the CME exchange. By mid-May, the number of long positions of Money Manger, which are the main buyers of oil, increased by 85%, to 373,000 contracts, which became the highest value since October 2018. This served as a driver for the rapid recovery of oil quotes, which in May reached $35 for the WTI #CL grade. Brent oil quotes soared even higher.
Naturally, recovery is never straightforward, and before the price of oil enters a stable trajectory, quotes may decline under the influence of market negative factors. In this regard, after such a rapid growth, we can very well expect the correction of WTI #CL oil to the level of $29 or even $25. However, it is unlikely that we should again assume a deep drop in oil prices below $ 20.
Figure 1: Short-term WTI Oil Price Forecast
In its short-term energy forecast published last week, the US Energy Information Agency - USEIA suggested that 2020 Brent crude oil prices would reach $34 per barrel. The EIA expects that prices will average $23 per barrel in the second quarter of 2020, and then increase to $32 in the second half of the year. The EIA predicts that Brent crude oil prices will rise to an average of $48 per barrel in 2021, as the decline in global oil reserves will put increasing pressure on quotes. Pointing to great uncertainty, the agency suggests the restoration of the price of WTI varieties to the level of $34 only in December 2020.
At the same time, speaking about the current oil production in the US, the US EIA assumes a drop in production of only 800,000 barrels per day, which, as we understand it, cannot have a significant impact on shale oil. At the same time, not long ago, there was an opinion in the markets that the break-even price for US shale producers should be about $70 per barrel. However, for promising wells, the cost price can be as low as $30-35, and with the development of technologies it can become even lower.
On the whole, very little time will pass, and if prices reach a stable growth area above $30, the US shale industry will quickly recover. Two or three months is enough for everything to work, as before. In terms of price levels, $25-30 is enough for the industry to come to life.
Now the shale oil market is entering a phase of mergers and acquisitions when large producers such as Exxon, Chevron, BP, Shell and Total, begin to acquire small producers and integrate them into their business model. At the same time, the US is not limited by OPEC++ agreements and can continue to capture markets, relying on a geopolitical strategy of domination, creating problems for its competitors.
Be careful and cautious, follow the rules of money management. Let the coronavirus pass us!
*The market analysis posted here is meant to increase your awareness, but not to give instructions to make a trade.
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