OPEC vs IEA: Who"s Right On Oil Prices?

Authored by Nick Cunningham via OilPrice.com,

Last week, the International Energy Agency made a lot of OPEC brows furrow when it warned that 2018 may not be a very happy new year for the cartel.

U.S. shale supply, the IEA said in its December Oil Market Report, is set to grow more than OPEC has estimated and this could be the undoing of the production cut that boosted prices this year.

OPEC, for its part, has insisted that U.S. shale production won’t grow as much as the IEA says, baffling some observers who now wonder who they should believe. But let’s put it another way: If the coach of a football team tells you that his team will win the cup because they’re the best, but the football association has estimated that the team is not the best one in the league, who would you believe?

OPEC has a history of underestimating U.S. shale. This underestimation led to the glut that sank prices in 2014. Now it stands to reason that the cartel is more cautious in its estimates of U.S shale oil developments, but this caution does not necessarily have to be reflected in comments. Let’s not forget that comments from OPEC officials—whether or not grounded in facts—have had a direct and immediate effect on prices from events such as the shutdown of the Forties pipeline network last week.

So, it would make sense to lean more towards what the IEA says, and it says that non-OPEC supply next year will probably rise by 1.6 million bpd—a 200,000 bpd upward revision on the previous OMR. U.S. shale production alone will, according to IEA’s latest estimate, grow by 870,000 bpd in 2018. Meanwhile, demand will rise by 1.3 million barrels daily next year, hinting at another glut in the making. 

Now, OPEC’s last forecast is that non-OPEC supply next year will rise by just 990,000 bpd next year to 58.81 million bpd, although the group does caution that any non-OPEC supply growth forecast involves considerable uncertainties regarding U.S. shale production growth. For the U.S. specifically, OPEC forecasts a 1.05-million-barrel daily supply growth next year, which will be partially offset by declines in producers such as Russia, China, and Mexico, among others.

That’s quite a discrepancy between IEA and OPEC figures, but it’s not the only one. The two more notably disagree on when the glut will be over. IEA is skeptical about it disappearing before the end of next year, while OPEC is upbeat, believing the market will return to balance in the second half of 2018 as demand growth accelerates. 

Sometimes OPEC’s forecasts sound like developments that the cartel can will into existence, and this market rebalancing forecast is one of these cases. It’s true that some OPEC members have been very diligent in their compliance to the lower production quotas. Others not so much, so those from the first group have actually cut more than they agreed to in order to compensate for the non-compliant ones.

Can the overachievers continue doing this to ensure the forecast materializes? They can, but they can’t do anything about U.S. shale, and it’s uncertain whether Russia will stay in the agreement after the end of June: Moscow has indicated it would rather quit as soon as politely possible. OPEC also has another problem that’s been there since the original deal, but recently has been garnering more attention. With oil prices higher, how long until one or more OPEC members decide to drop the deal and cash in on the price increase?

The "Unknown Unknowns" That Threaten U.S. Shale

Authored by Tsvetana Paraskova via OilPrice.com,

Three years after the oil price crash, the U.S. shale patch is on its second growth phase and is expected to continue to increase its production, at least through the next five years.

The global oil markets have become increasingly dependent on U.S. tight oil supply - and the oil industry is still coming to grips with this new reality, Simon Flowers, Chairman and Chief Analyst at Wood Mackenzie, wrote in a recent article.

Current projections put the Permian on the forefront of the United States’ ability to deliver increased tight oil supply to the global markets. However, forecasts for the shale patch are as dynamic as production and drilling rates are. And some ‘known unknowns’ have been surfacing such as higher gas-to-oil ratios in some wells, and the parent/child wells issue, Flowers says.

Wood Mackenzie said last month that signs had started to show that intensified drilling in the Permian doesn’t deliver commensurate volumes of oil. Although WoodMac thinks that such setbacks could just be growing pains and Permian drillers could indeed ‘change the laws of physics’, it had warned three months ago that drillers might soon start to test the region’s geological limits. If exploration and production companies can’t overcome the geological constraints with tech breakthroughs, Permian production could peak in 2021, putting more than 1.5 million bpd of future production in question and potentially significantly influencing oil prices, WoodMac said in September.

In his December article, WoodMac’s Flowers included this observation in the Permian’s ‘known unknowns’:

“Growth might also be constrained by shareholders demanding that independents rein back from volume-driven targets.”

Those ‘known unknowns’ serve as a warning: the oil market can’t be complacent and just assume that the Permian boom will deliver as expected, according to Flowers. The Wolfcamp may be the star of the Permian, WoodMac says, but “there are more than likely ‘unknown unknowns’ out there too. And if there are, there’s not another Permian ready to step in; and conventional options will take time to crank into action.”

The Eagle Ford and the Bakken combined represent nearly half of the current U.S. tight oil production, according to Wood Mackenzie, which is expressing new doubts that those two plays could offer long-term commercial drilling inventory as operators move out beyond the sweet spots. Therefore, the analysts downgraded the growth rates for both plays from the mid-2020s, but have significantly upgraded the Permian growth pace, especially for the Wolfcamp basin.

If the Permian turns out to have ‘unknown unknowns’ alongside the ‘known unknowns’, the U.S. shale patch may not deliver as expected.

Currently, WoodMac’s supply/demand balance forecasts show that the U.S. and OPEC will “do battle for contestable demand that will climb to over 5 million b/d by 2024.”

The analysts believe that U.S. shale will take the lion’s share of that demand—90 percent—as its production will double to 9.6 million bpd by 2024 from 4.9 million bpd in 2017, while OPEC will be left with meeting less than 1 million bpd of that additional demand.

Three years after the oil price crash, the most unexpected outcomes in the global oil market are the second wave of U.S. shale growth, OPEC’s “zealous adherence” to the cuts, and the resilience of some non-OPEC non-U.S. producers, WoodMac says.

While Mexico, China, and Africa as a whole have been “heavy casualties” of the lower-for-longer oil prices, Russia, Canada, and the North Sea have surprised on the positive side by adapting remarkably well to the low oil prices. Russia is the “poster child” of this resilience. Canada is also doing well with Duvernay liquids where breakevens are competitive with U.S. plays, and with better uptime from oil sands projects. The North Sea has also been a positive surprise, with the UK leading the way with aggressive cost cuts that have helped to raise oil production, WoodMac says.

Still, U.S. tight oil, especially the Permian, will be the main growth story over the medium term, but ‘unknown unknowns’ may be lurking out there and could restrain the pace of that growth.

WTI/RBOB Spike On OPEC Headlines After Bearish Inventory/Production Data

Update: WTI/RBOB was fading after DOE data but then Kuwait dropped the following meaningless headline: OPEC JMMC RECOMMENDS EXTENSION, DIDN"T FINALIZE DURATION. And the algos took over...

*  *  *

Last night"s API-reported surprise crude build sparked selling that not even Russia/Saudi jawboning could rescue, but DOE data showed the exact opposite with a big crude draw and even bigger gasoline draw. Added to a new record high in US crude production and RBOB is fading and WTI is not rallying.

As Bloomberg reports, the U.S. has proven at least one thing this year with its expansion of crude and products exports: we are becoming more energy independent than ever before.

Last week net imports of all crude and refined products dipped to a new record low.

That"s coupled with record-high gasoline exports, a truly spectacular sea change in our world"s oil flows.

API

• Crude +1.82mm (-2.95mm exp)


• Cushing -3.178mm - most since Sept 2009


• Gasoline -1.529mm (+1.2mm exp)


• Distillates +2.696mm (+200k exp) - biggest since July

DOE

• Crude -3.43mm (-2.95mm exp)


• Cushing -2.914mm - biggest draw since Sept 2009


• Gasoline +3.63mm (+1.2mm exp) - biggest build since July


• Distillates  (+200k exp) - biggest buils since Jan

DOE data showed the exact reverse of API with big surprise draw in crude and build in gasoline... Additionally Cushing saw the biggest destocking since Sept 2009 last week...

US crude production rose 24k b/d - to a new record high...

Gasoline exports hit a record high...

 

WTI was lower and RBOB higher heading into the DOE data but the trend reversed after on the surprise bearish product builds...

OPEC, Russia Said To Announce Oil Pact Extension On Nov 30

Authored by Tsvetana Paraskova via OilPrice.com,

Saudi Arabia and Russia have agreed that OPEC and non-OPEC allies should announce an extension of the cuts at the highly-anticipated meeting in Vienna on November 30, Bloomberg reported on Friday, quoting people involved in the talks.

Recent OPEC/non-OPEC oil pact chatter had it that Saudi Arabia was pushing for an announcement of the cuts extension next week in Vienna, while Russia was more hesitant about telling the market on November 30 how the participants in the deal would act. Russia appeared to be stalling and playing for an announcement to be issued closer to the current expiration deadline of the deal, March 2018.

According to Bloomberg’s sources, now Russia and Saudi Arabia have agreed on the need to announce some sort of a deal next week, but Russia has insisted on additional phrasing in the extension deal that would link the size of the cuts to the state of the oil market.

While OPEC and Russia have agreed on a general framework, discussions are ongoing as to how OPEC could meet Russia’s demands, including how to include a link between the size of the cuts and the state of the rebalancing of the oil market. There are also discussions about including an option to review the pact again in early 2018, including calling a new meeting, according to Bloomberg’s sources.

As of last week, not all Russian oil companies were on board with extending the cuts, and they were said to have discussed a six-month extension with Energy Minister Alexander Novak.

Novak, for his part, said on Friday in a television interview posted on the energy ministry’s website that some 50 percent of the global oil oversupply had been erased and Brent prices had risen to an “acceptable enough” level of more than $60 a barrel.

Nevertheless, the oil market is not yet balanced and the pact needs to be extended, Novak said, adding that Russia supports an extension, and various options are being discussed.

Details will be discussed at the Vienna meeting next week, he noted. 

 

As Oil Heads For Down-Week, Crude Stakes Are Huge

After five straight weeks higher - read by many as confirmation of how awesome the global coordinated recovery must be - WTI and Brent dropped this week as inventories rose, demand outlooks dimmed, and OPEC hope faded.

As Alhambra Investment Partners" Jeffrey Snider notes, there is a titanic struggle going on right now in the oil market.

On the one side of the futures market are the usual pace setters, the money managers. Last week, the latest COT data available, they went the most net long since March. If it continues, it will close in on the most positive futures position since the record long they established back in February.

Normally that would be insanely bullish for oil prices. But just as in February/March another part of the futures market has intervened on the other side. Back then it was the oil producers who rising inventory forced into a larger and larger offsetting net short (hedge).

This time, however, it is the swap dealers who are short for reasons that aren’t really clear. The weekly COT report for the last week in October showed a record net short for dealers, just beating their most extreme position from the middle of 2013 at -424k contracts. In the first week and November, they blew away that record at -470k.

It clearly matters because in 2017 the oil market has changed. It may be the inventory story, or it may be the exit of producers from hedging that inventory and other products. Whatever the case, money managers just aren’t setting the price like they used to. And it could be that managers have changed their market activities, too, where other parts of the futures market are now cueing off (shorting) this possible difference. I honestly don’t know what it is, but I can safely point out where it is.

Now with swap dealers apparently showing very, very strong conviction on the short side, oil prices can’t gain any traction beyond the $57 established by in all likelihood geopolitical risk.

The fundamentals of oil continue to favor the dealers over the managers, with oil inventories remaining at the same crisis “rising dollar” levels. Being slightly better than 2016 is not a real achievement toward clearing the leftover physical imbalance, not when oil inventories are instead still consistent with late 2014. With 2017 nearly over, there should have been much more progress toward 2013 levels of stock long before now if there was ever going to be a realistic chance to balance the oil market next year (at the most optimistic).

Instead, it indicates yet again a demand problem, as in lack of materializing upside demand due to, as always, economic constraints that in the mainstream aren’t ever considered real (like when the oil crash was called repeatedly a “supply glut”). Pushing the expected rebalancing date into 2019 or even (more realistically) 2020 creates greater downside not upside risks.

That may be why dealers have jumped all over the shorts; if it is geopolitical risks driving oil prices higher, and maybe what managers are betting on now, then if or when they fade the negative fundamentals of oil will be re-imposed on the price. That seems to be what the futures curve is saying, too.

Backwardation indicates expected balance, but at a very low price rather than a rebounding one. In the latest oil pullback since last week, the curve has moved lower in unison, with the same almost identical indicated backwardation rather than toward any serious rewind toward contango.

One additional factor to consider is those record and near-record opposite futures positions. What happens if the oil price starts to move in either direction? There may need to be a whole lot of covering by whichever side ends up on the losing end, perhaps turbocharging the price as it begins to move whatever way it decides to go.

There is right now a lot at stake in the crude market, and it’s not just about oil.

WTI/RBOB Slide On Surprise Build As US Crude Production Hits New Record High

WTI/RBOB extended yesterday"s IEA-driven losses after a big crude build reported overnight by API, and DOE did nothing to assuage that with a 1.85mm crude build (admittedly smaller than API"s projected 6.5mm, but notably different from the 2.4mm draw expected), Gasoline also surprised with a build and WTI/RBOB extended losses. Additionally US Crude production rose to a new record high.

Bloomberg Intelligence energy analyst Fernando Valle notes:

Weaker demand drove a negative print for crude and product stocks. Strong refinery runs and rising crude exports were not enough to offset rising U.S. crude production. This latest increase, combined with reduced demand for refined products should put a damper on the oil-price recovery.

API

• Crude +6.513mm  (-2.4mm exp) - biggest build in 9 months


• Cushing -1.803mm - biggest draw in 4 months


• Gasoline +2.399mm (-1.5mm exp) - biggest build in 3 months


• Distillates -2.527

DOE

• Crude +1.854mm (-2.4mm exp)


• Cushing -1.504mm


• Gasoline +894k (-1.5mm exp)


• Distillates -799k

DOE data confirmed API"s reported builds in crude and gasoline (and a big drawdown in Cushing stocks)

US Crude production reached a new record high the previous week - not what OPEC hoped for - and last week"s big surge in the rig count suggests this is not about to slowdown as iot rose 25k b/d to a new record high...

 

WTI was hovering right at $55 heading into the DOE data and broiefly broke below on the print. RBOB is notably weaker...

“All of a sudden it seems that positives are in short supply for market bulls,” PVM Oil Associates analyst Stephen Brennock wrote in emailed report. “Yesterday’s slide is being compounded this morning by a fresh dose of price angst” sparked by the API report

Satellite Images Reveal Saudis May Be Lying How Much Oil They Have In Storage

A little over a year ago, specialized satellite imaging company Orbital Insight which uses its proprietary imaging and algorithms to track above-ground oil storage, confirmed something we had alleged earlier in the year: that China was vastly under-representing the amount of oil it had stored in its Strategic Petroleum Reserve (with significant implications for prices). As we said last September "according to Orbital Insight, China had not only misrepresented how much oil it has stored, it has done so at a massive scale, with the real number dwarfing even JPM own estimate: the real amount of Chinese oil in storage, according to Orbital, was a whopping 600 million barrels as of May" an amount nearly 3 times greater than the official, at the time, number of 234 million barrels.

The resultant doubt about China"s true purchasing capacity was one of the several factors that led to the subsequent swoon in oil prices which OPEC was unable to overcome until nearly a year later, when the market became increasingly confident that the OPEC strategy of eliminating excess inventory, was working and pushed the price of WTI and Brent to two year highs, above $57 and $63 respectively.

That confidence may not last, however, and the reason may be the same one as last year: Orbital Insights.

As the FT"s David Sheppard writes, "while the oil market’s attention has been gripped this week by the corruption purge in Saudi Arabia and its tensions with Iran, from miles above the earth’s crust one company is highlighting a different kind of intrigue."  He is, of course, referring to Orbital Insight, whose analysis of Saudi crude inventories in recent months has thrown up an "interesting anomaly."

One can call it an "anomaly", but a better explanation of what the company has done is to catch the Saudi kingdom in lying about its inventories. Here is the official narrative:

The kingdom, which has led Opec and Russia in co-ordinated output cuts since January, has for months been reporting to official agencies that its oil held in storage has been falling, which alongside lower production has been one factor that has helped propel Brent crude oil back above $60 a barrel.

There is just one problem: it"s a lie: "Orbital’s analysis of satellite imagery suggests that Saudi Arabia’s above-ground tanks — whose floating roofs allow them to see when oil inventories are rising or falling by measuring shadows cast across the top of the tanks — have seen no real change in the past 18 months."

This, Orbital says, is interesting because before early 2016, movements in above-ground storage closely tracked the trend in Saudi’s official numbers submitted to the Joint Organisations Data Initiative that are crucial for traders and analysts trying to get a grip of the near 100m barrel-a-day oil market.

In other words, the Saudis did not always lie about their inventory - it"s only recently that the nation decided to "pull a China" and misrepresent its true crude inventories... in fact, it only started as OPEC began aggressively jawboning the market to send the price of oil higher in the buildup to the Nov 2016 Vienna production cut agreement. In the process, OPEC"s most important member would do anything to give the fake impression there is more demand, and thus less oil in storage, than there really was.

How much? Here"s the FT"s punchline: "While Saudi Arabia has reported to Jodi that its oil stocks have declined by about 70m barrels since early 2016, the Orbital analysis suggests the above-ground tanks have actually seen inventories rise marginally over the same period."

If confirmed, Orbital"s startling allegation would imply that for much of the past two years, OPEC has been actively engaged in doing what it does best: cheating, not only the market, but also other cartel members, because if Saudi peers found out that Saudi Arabia was quietly warehousing tens of millions of barrels in excess oil to give the false impression of high demand, then everyone else would start doing it. Come to think of it, maybe they are...

Still, as the FT and Orbital point out, there are a few caveats.  For one, Saudi Arabia’s official storage numbers include oil held overseas, in key regional hubs. It also covers line-fill for pipelines and underground tanks that cannot be monitored by eyes in the sky.  These factors may account for why the numbers no longer seem to match up — though they do raise other questions. Orbital says that changes in inventory levels in above-ground domestic storage tanks are normally noticeable normally first as they are easiest to access. Saudi’s Jodi numbers and what Orbital can see through its algorithmic analysis of the satellite imagery had previously tracked each other closely.

“The floating tank data is the part that we think is most indicative of short-term changes in storage,” said James Crawford, chief executive of Orbital Insight. “The big question is why that no longer jives with the government data that shows a pretty big drop."

There may be another explanation and it has to do with keeping higher oil storage levels at home than abroad. As the FT explains, "the most intriguing suggestion for the shift is more strategic: Riyadh’s own concerns about rising tensions with its neighbours."

“[The] reason for no real deep stock draw in [the] kingdom will be mainly security related,” said Cyril Widdershoven, who runs the Verocy consultancy.

 

That suggests, he said, that Saudi Arabia is concerned enough about its deteriorating relationship with Iran, and to a lesser degree Qatar, to keep higher oil stocks at home in case of any disruption.

To be sure, with Crown Prince Mohammed bin Salman saying this week that Iran’s support for Houthi fighters in Yemen, and the provision to them of missiles capable of striking deep into the kingdom, constitutes an act of war, "it is certainly an intriguing theory", one which Shepperd writes that "at times of heightened tension between two of Opec’s biggest producers it is one the market may start tracking closely."

And while there is no definitive explanation for the inventory discrepnacy observed by Orbital, what makes this mystery especially intriguing is how polar opposite the two most likely explanation are in terms of oil prices: either Saudi Arabia is covering up the lack of demand and warehousing excess oil, which will eventually send oil prices sliding, or if the "security-related" explanation is accurate, then Saudi Arabia is indeed preparing for war with Iran, which once the shooting begins will send the price of oil into the stratosphere.

"Take That OPEC" - WTI Slides As US Crude Production Jumps To Record High

WTI/RBOB extended losses post-API data overnight, but DOE data sparked some algo chaos as a surprise crude build (+2.24mm vs -2.45mm exp) was offset by a bigger than expected gasoline draw (exactly opposite what API reported). In addition, US crude production jumped to a new all-time high - take that OPEC!

 

API

• Crude -1.562mm (-2.45mm exp)


• Cushing +812k


• Gasoline +520k (-1.85mm exp)


• Distilates-3.133mm

ADOEPI

• Crude +2.24mm (-2.45mm exp)


• Cushing +720k


• Gasoline -3.31mm (-1.85mm exp)


• Distilates -3.359mm

Last night"s API data showed smaller crude draw and a surprise gasoline build, but DOE surprised with a big crude build and biugger gasoline draw (and a notable build in Cushing stocks)...

 

Production has normalized back at cycle highs as storm effects fade, surging to new cycle highs in the last week

 

And total US Crude output just hit a new record high...

 

The trend is not OPEC"s friend...

 

WTI was back below $57 and RBOB below $1.80 ahead of the DOE data, sinking after last night"s surprise gasoline build

“If the EIA data disappoints then it could take further steam off the market,” says Jan Edelmann, analyst at HSH Nordbank.

WTI Spikes Over $57 For The First Time Since July 2015

Having legged higher at the opens of Asia, Europe, and US markets, WTI is extending gains overnight on middle-east tensions...

Brent is trading above $62 amid anti-corruption drive led by Saudi Crown Prince Mohammed bin Salman, which may consolidate his control in OPEC’s largest oil producer, and WTI has pushed above $57 as producers such as Nigeria, Saudi Arabia signal they support a potential extension of OPEC output cuts.

“We have political uncertainty, risk of political instability in this major oil producing country and also unforeseen implications for the entire region,” Commerzbank analyst Carsten Fritsch says by phone.

 

“It justifies a certain risk premium in the oil price...

 

At the moment you’d have to be brave to bet against Brent."

And everyone and their pet rabbit is record long the energy complex.

Is The Aramco IPO On The Brink Of Collapse?

Authored by Nick Cunningham via OilPrice.com,

In what could be a humiliating decision, Saudi Aramco is considering not staging an IPO next year as planned, due to the difficulty of pulling off an international listing.

On Friday, the Financial Times reported that Aramco is weighing a different strategy: selling stakes in the company to private investors and sovereign wealth funds. No final decision has been made yet, but there are several potential paths forward, including a public listing on Saudi Arabia’s domestic stock exchange plus a private sale. Or a private sale followed by an international listing, but maybe not until 2019.

Aramco officials tried to beat back the report, insisting that everything is moving forward as planned. “A range of options, for the public listing of Saudi Aramco, continue to be held under active review. No decision has been made and the IPO process remains on track,” Saudi Aramco said in a statement, according to the FT.

However, Reuters echoed the FT, reporting on Friday that Aramco was in talks with a Chinese investor.

Saudi officials, according to the FT, are concerned about the legal risks involved in taking the company public. The powerful crown prince has favored a New York listing, due to the political alliance with the U.S., while some Aramco officials and financial advisors prefer a less risky listing in London. A New York listing could expose Aramco to legal action stemming from Saudi Arabia’s alleged role in the 9/11 attacks—legislation passed by the U.S. Congress in late 2016 authorizes lawsuits from 9/11 victims against Saudi Arabia.

But a London listing is apparently not that much more attractive. Saudi sources told the FT that Aramco would face tough legal scrutiny there as well.

Those roadblocks have led to second thoughts on the IPO altogether, with Saudi officials reportedly now considering a private sale.

After hyping the IPO for more than a year, shelving the plans would amount to a significant climb down for the state-owned oil company.

On the other hand, as Bloomberg Gadfly points out, there are also upsides to a private sale that go beyond the difficulties of listing in New York or London. For instance, if Aramco attracts a disappointingly low sale figure, that figure could remain undisclosed if the sale was private. Also, Saudi Arabia could deepen its ties to Asia if it makes a private sale to major investors in China or India. Finally, Aramco would not have to publish estimates on its oil reserves – a long held state secret.

In addition, Saudi Arabia might have troubles engaging in coordinated production cuts within OPEC if it listed in New York, a practice that might be considered price fixing, and thus illegal.

But, even with all of that said, scrapping the IPO would amount to a defeat. It would also raise deeper questions about the country’s finances and its long-term fiscal health. The IPO has been billed as the largest ever public offering, with Saudi officials boasting that Aramco is worth some $2 trillion, which would translate into around $100 billion for 5 percent of the company. Independent analysts dispute those figures, estimating the company could be worth maybe only half of that.

While the precise figure is up for debate, few doubt it will be large, playing a crucial role in the country’s plan to diversify the economy. Saudi Arabia’s National Transformation Program (NTP) consists of a series of economic reforms aimed at accelerating growth, cutting spending on wasteful subsidies, while also raising tax revenue from non-oil sources. There is a bit more urgency to stimulate the economy because of Saudi Arabia’s sizable budget deficit and the fact that the economy entered a recession this year, in part because of the government’s own austerity measures.

The IPO of Aramco is considered a pivotal move that could address a lot of these problems all at once.  But Saudi officials have been hoping to time an IPO with oil prices trading at least as high as $60 per barrel. However, rebalancing the oil market and lifting prices has taken much longer than expected. In that context, it is no surprise that the Saudi King made his first visit to Russia earlier this month, desperate to make the OPEC deal work, not only for higher oil prices in the near-term, but to set the state for the country’s highly-anticipated IPO.

A decision not to take Aramco public would be a major setback.

The Death Of Petrodollars & The Coming Renaissance Of Macro Investing

Authored by John Curran via Barrons,

The petrodollar system is being undermined by exponential growth in technology and shifting geopolitics. What comes next is a paradigm shift...

In the summer of 1974, Treasury Secretary William Simon traveled to Saudi Arabia and secretly struck a momentous deal with the kingdom. The U.S. agreed to purchase oil from Saudi Arabia, provide weapons, and in essence guarantee the preservation of Saudi oil wells, the monarchy, and the sovereignty of the kingdom. In return, the kingdom agreed to invest the dollar proceeds of its oil sales in U.S. Treasuries, basically financing America’s future federal expenditures.

Soon, other members of the Organization of Petroleum Exporting Countries followed suit, and the U.S. dollar became the standard by which oil was to be traded internationally. For Saudi Arabia, the deal made perfect sense, not only by protecting the regime but also by providing a safe, liquid market in which to invest its enormous oil-sale proceeds, known as petrodollars. The U.S. benefited, as well, by neutralizing oil as an economic weapon. The agreement enabled the U.S. to print dollars with little adverse effect on interest rates, thereby facilitating consistent U.S. economic growth over the subsequent decades.

An important consequence was that oil-importing nations would be required to hold large amounts of U.S. dollars in reserve in order to purchase oil, underpinning dollar demand. This essentially guaranteed a strong dollar and low U.S. interest rates for a generation.

[ZH: Still, the underlying concept of how Petrodollar recycling, or as some call it, petrocurrency mercantilism works, leaves some confusion. So in order to alleviate that, here courtesy of Cult State, is a quick and simple primer that should hopefully answer all questions. From CultState:

So what is petrocurrency mercantilism?

It’s when a national bank and an energy producer collude to generate artificial demand for a currency at the expense of the purchasing power of other currencies.

The flowchart below shows how it all works.

Given this backdrop, one can better understand many subsequent U.S. foreign-policy moves involving the Middle East and other oil-producing regions.

Recent developments in technology and geopolitics, however, have already ignited a process to bring an end to the financial system predicated on petrodollars, which will have a profound impact on global financial markets. The 40-year equilibrium of this system is being dismantled by the exponential growth of technology, which will have a bearish impact on both supply and demand of petroleum. Moreover, the system no longer is in the best interest of key participants in the global oil trade. These developments have begun to exert influence on financial markets and will only grow over time. The upheaval of the petrodollar recycling system will trigger a resurgence of volatility and new price trends, which will lead to a renaissance in macro investing.

Let’s examine these developments in more detail.

First, TECHNOLOGY is affecting the energy markets dramatically, and this impact is growing exponentially. The pattern-seeking human mind is built for an observable linear universe, but has cognitive difficulty recognizing and understanding the impact of exponential growth.

Paralleling Moore’s Law, the current growth rate of new technologies roughly doubles every two years. In the transportation sector, the global penetration rate of electric vehicles, or EVs, was 1% at the end of 2016 and is now probably about 1.5%. However, a doubling every two years of this level of usage should lead to an automobile market that primarily consists of EVs in approximately 12 years, reducing gasoline demand and international oil revenue to a degree that today would seem unfathomable to the linear-thinking mind. Yes, the world is changing—rapidly.

Alternative energy sources (solar power, wind, and such) also are well into their exponential growth curves, and are even ahead of EVs in this regard. Based on growth curves of other recent technologies, and due to similar growth rates in battery technology and pricing, it is likely that solar power will supplant petroleum in a vast portion of nontransportation sectors in about a decade. Albert Einstein is rumored to have described compound interest (another form of exponential growth) as the most powerful force in the universe. This is real change.

The growth of U.S. oil production due to new technologies such as hydraulic fracturing and horizontal drilling has both reduced the U.S. need for foreign sources of oil and led to lower global oil prices. With the U.S. economy more self-reliant for its oil consumption, reduced purchases of foreign oil have led to a drop in the revenues of oil-producing nations and by extension, lower international demand for Treasuries and U.S. dollars.

ANOTHER MAJOR SECULAR CHANGE that is under way in the oil market comes from the geopolitical arena. China, now the world’s largest importer of oil, is no longer comfortable purchasing oil in a currency over which it has no control, and has taken the following steps that allow it to circumvent the use of the U.S. dollar:

• China has agreed with Russia to purchase Russian oil and natural gas in yuan.


• As an example of China’s newfound power to influence oil exporters, China has persuaded Angola (the world’s second-largest oil exporter to China) to accept the yuan as legal tender, evidence of efforts made by Beijing to speed up internationalization of the yuan. The incredible growth rates of the Chinese economy and its thirst for oil have endowed it with tremendous negotiating strength that has led, and will lead, other countries to cater to China’s needs at the expense of their historical client, the U.S.


• China is set to launch an oil exchange by the end of the year that is to be settled in yuan. Note that in conjunction with the existing Shanghai Gold Exchange, also denominated in yuan, any country will now be able to trade and hedge oil, circumventing U.S. dollar transactions, with the flexibility to take payment in yuan or gold, or exchange gold into any global currency.


• As China further forges relationships through its One Belt, One Road initiative, it will surely pull other exporters into its orbit to secure a reliable flow of supplies from multiple sources, while pressuring the terms of the trade to exclude the U.S. dollar.

The world’s second-largest oil exporter, Russia, is currently under sanctions imposed by the U.S. and European Union, and has made clear moves toward circumventing the dollar in oil and international trade. In addition to agreeing to sell oil and natural gas to China in exchange for yuan, Russia recently announced that all financial transactions conducted in Russian seaports will now be made in rubles, replacing dollars, according to Russian state news outlet RT. Clearly, there is a concerted effort from the East to reset the economic world order.

ALL OF THESE DEVELOPMENTS leave global financial markets vulnerable to a paradigm shift that has recently begun. In meetings with fund managers, asset allocators, and analysts, I have found a virtually universal view that macro investing—investing based on global macroeconomic and political, not security-specific trends—is dead, fueled by investor money exiting the space due to poor returns and historically high fees in relation to performance. This is what traders refer to as capitulation. It occurs when most market participants can’t take advantage of a promising opportunity due to losses, lack of dry powder, or a psychological inability to proceed because of recency bias.

A current generational low in volatility across a wide spectrum of asset classes is another indicator that the market doesn’t see a paradigm shift coming. This suggests that current volatility is expressing a full discounting of stale fundamental inputs and not adequately pricing in the potential of likely disruptive events.

THE FEDERAL RESERVE is now in the beginning stages of a shift toward “normalization,” which will lead to diminished support for the U.S. Treasury market. The Fed’s total assets stand at approximately $4.5 trillion, or five times what they were prior to the financial crisis of 2008-09. The goal of the Fed is to “unwind” this enormous balance sheet with minimal market disruption. This is a high-wire act a thousand feet in the air without a safety net or prior practice. Additionally, at some not-so-distant future date, the U.S. will need to finance enormous and growing entitlement programs, and our historical international sources for that financing will no longer be willing to support us in that endeavor.

The market participants with whom I met theoretically could have the ability to accept cognitively the points made in this article. But the accumulation of many small losses in a low-volatility and generally trendless market has robbed them of confidence and the psychological balance to embrace any new paradigm proactively. They are frozen with fear that the lower- return profile of recent years is permanent—ironic in an industry that is paid to capture price changes in a cyclical world.

One market legend with whom I spoke suggested he wouldn’t have had the success he enjoyed in his career had he begun in the past decade. Whether or not this might be true, it doesn’t mean that recent lower returns are to be extrapolated into the future, especially when these subpar returns occurred during the quantitative-easing era, a period that is an anomaly.

I have been fortunate to ride substantial bets on big trends, earning high risk-adjusted returns using time-tested techniques for exploiting these trends. Additionally, I have had the luxury of not participating actively full-time in macro investing during this difficult period. Both factors might give me perspective. I regard this as an extraordinarily opportune moment for those able to shed timeworn, archaic assumptions of market behavior and boldly return to the roots of macro investing.

The opportunity is reminiscent of the story told by Stanley Druckenmiller, who was promoted early in his investment career to head equity research at a time when his co-workers had vastly more experience than he did. His director of investments informed him that his promotion owed to the same reason they send 18-year-olds to war; they are too dumb to know not to charge. The “winners” under the paradigm now unfolding will be market participants able to disregard stale, anomalous concepts, and charge.

RELATEDLY, THERE IS a running debate as to whether trend-following is a dying strategy. There is plenty of anecdotal evidence that short-term and mean-reversion trading is more in vogue in today’s markets (think quant funds and “prop” shops). Additionally, the popularity of passive investing signals an unwillingness to invest in “idea generation,” or alpha. These developments represent a full capitulation of trend following and macro trading.

Ironically, many market players who wrongly anticipated a turn in recent years to a more positive environment for macro and trend-following are throwing in the towel. The key difference is that now there is a clear catalyst to trigger the start of the pendulum swinging back to a fertile macro/trend-following trading environment.

As my mentor, Bruce Kovner [the founder of Caxton Associates] used to say, “Nobody rings a bell at key turning points.” The ability to properly anticipate change is predicated upon detached analysis of fundamental information, applying that information to imagine a plausible world different from today’s, understanding how new data points fit (or don’t fit) into that world, and adjusting accordingly. Ideally, this process leads to an “aha!” moment, and the idea crystallizes into a clear vision. The thesis proposed here is one such vision.

OPEC To Take Drastic Action Despite Shale Slowdown

Authored by Nick Cunningham via OilPrice.com,

WTI recently dipped below $50 per barrel for the first time in a month, erasing the strong September rally. It’s no coincidence that after two weeks of price declines, OPEC has tried to talk up the oil market again, hinting that more drastic action could be forthcoming.

Echoing the world’s top central bankers, OPEC’s Secretary General said that the oil cartel might need to take “extraordinary” measures to balance the oil market next year. “There is a growing consensus that, number one, the re-balancing process is underway,” OPEC’s Mohammad Barkindo told reporters on Sunday in New Delhi. “Number two, to sustain this into next year, some extraordinary measures may have to be taken in order to restore this stability on a sustainable basis going forward.”

As always, OPEC is vague on the specifics, but the working assumption is that the group will agree to an extension of the cuts until at least mid-2018, or perhaps even as late as through the end of the year. There’s been some discussion about deeper production cuts, but there aren’t a ton of analysts who see OPEC going that far, despite Barkindo’s cryptic language.

Meanwhile, Saudi Arabia engaged in a bit of its own psy-ops with the oil market on Monday, saying that it was taking “unprecedented” steps to cut its oil exports. Saudi Aramco said it would lower exports by 560,000 bpd next month, “the deepest customer allocation cuts in its history.”

The comments are consistent with the country’s longstanding pattern of trying to jawbone the market when it wants higher prices. Based on Monday’s activity, the effort didn’t work.

“The fact that we did not get any significant strength from the Saudi news is rather disheartening for the bulls,” Stephen Schork, an analyst and author of the Schork Report, told the WSJ. “The market is very skeptical of this.”

Of course, real cuts to oil exports will be felt if they are carried out, but after a few years of getting jerked around by every utterance from OPEC, the markets want to see proof in the pudding. Aggressive rhetoric no longer moves the market the way it did a year ago, so we’ll have to just wait and see what OPEC does at its November meeting.

“With rising production levels and no definitive word from OPEC and the Russians that they are going to extend the cut or deepen it, the rally seems to have lost its momentum,” Gene McGillian, a market research manager at Tradition Energy, said in a Bloomberg interview.

That reaction seemed to be widespread on Monday. “I think that without the support of products and Brent, the market may get dragged lower in the near term as it’s apparent that the market doesn’t care much about OPEC already jawboning about an extension of the deal,” Scott Shelton, a broker at ICAP, told Reuters.

The ironic thing is that while OPEC ponders more drastic action, there are signs that U.S. shale is actually not doing as well as everyone thought it would be at this point. Production is up, but signs of strain are showing. The rig count fell last week, after weeks of unimpressive gains. The slowdown suggests the industry is becoming more cautious, particularly with oil prices running out of steam.

In fact, some cracks are becoming visible in the Permian basin, often cited as the most attractive shale basin in the U.S. Costs are on the rise and some drillers are running into production problems. Production is up, but profits are scarce.

That could lead to a wholesale rethink for the industry - the days of explosive growth in the shale patch could be coming to an end. A growing number of investors are demanding that E&Ps slow down and focus on profitability, which will likely come at the expense of the industry’s blistering growth rate.

OPEC has yet to enjoy the fruit of this potential receding tide of shale drilling - oil looks softer than it did a few weeks ago and hedge funds and other money managers have pared back their bullish bets lately, a harbinger of more cautious sentiment.  

But while OPEC is nervous about near-term oil prices, and is planning “extraordinary measures,” they can at least take comfort in the fact that the shale bonanza is moderating.

The Geopolitical Consequences Of U.S. Oil Exports

Authored by Kent Moors via OilPrice.com,

Two crucial things happened last week.

The first you may have noticed – oil prices moved back up briefly.

As for the second, most so-called “experts” seemed to have missed.

See, the environment we’re seeing in energy markets is very different from what we saw only a week ago, when oil prices were also rising.

Because last week also saw – for the first time in world history – a reigning Saudi Arabian monarch in Moscow for talks with Russia’s head of state.

Historically, Russia has been much closer to Iran – Saudi Arabia’s main regional enemy.

Now, King Salman and President Putin are expected to endorse the plan to extend the OPEC-Russia deal to cut oil production and boost prices beyond the current end date of March 2018.

But that’s not all they’re going to talk about…

Other, more far-ranging matters will also be on the agenda, including the war in Syria.

And the catalyst for this huge shift in global geopolitics is surprisingly simple.

It’s all about America’s record-breaking oil exports…

Russia and Saudi Arabia Need Each Other… for Now

Now, there’s no indication that Russia and Saudi Arabia are on the road to an alliance on anything beyond oil prices.

Even then, that accord remains only as long as it is in the subjective interest of the parties.

Nonetheless, it is disquieting to Washington that any such prospects may be on the horizon… or that U.S. oil exports may be introducing a range of foreign policy concerns.

From an energy perspective, the main issue at hand is the OPEC-Russian deal to cap oil production, which is now almost certain to continue further than the agreed-on end date of March next year.

And after some concerns had been raised over individual OPEC members exceeding the quotas the deal assigned them, evidence is now emerging that the restraint is holding.

As I’ve several times before here in Oil & Energy Investor, there’s no genuine alternative.

The major global sources of oil need to allow the worldwide market to rebalance.

That’s the only genuine basis for stability and a slow increase in prices.

Now, with some of Libya’s oil production coming back on line, it may seem like there’s less flexibility for some producers to increase their crude output and still “hide” within the overall figures set by the cap accord.

But that’s ignoring four major factors that could cut into oil supply, and send prices higher…

Massive problems are accelerating in Venezuela, Nigerian extraction levels remain under threat from domestic instability, non-OPEC producer Mexico faces a continuing shortfall, and even the news from Libya – that a major field is coming back online – belies the ongoing civil unrest there, and lack of forward production expectations.

The international balance between supply and demand will provide a rising price.

Yet that rise will remain a gradual one.

And this balance doesn’t actually mean that there will only be exactly as much oil available as is needed at any given time.

That kind of “just in time” availability, where crude is lined only to meet immediate demand, is a certain recipe for high volatility and huge spikes in price.

Even a minor problem could create chaos in the markets.

Rather, a stable balance presupposes a continuing surplus of excess market volume.

That not only cushions the pricing dynamics from wide swings in demand, but it also allows producers the luxury of being able to predict the price range.

Anybody in the business will tell you that this predictability is far more important to maintaining profit margins than are the occasional large jumps in price.

An operator’s financial survivability requires that futures sales be calculated into the estimate of the cost of producing the oil and selling it on.

These prices, called “wellhead prices,” are the real revenue a producer receives in the first arms-length transaction as oil comes out of the ground.

These prices are also well below the market price quoted throughout a trading day.

U.S. Oil Production is at Record Highs

But the primary caveat in all of this talk about an emerging balance remains U.S. production.

It’s once again increasing and now has a more immediate impact on global pricing levels than has been the case previously.

That’s because American exports have become a major factor in the global market.

For some time, oil prices have not been determined by what occurs in developed markets of North America and Western Europe.

West Texas Intermediate (WTI) and Brent, the benchmark crude rates set in New York and London, may dictate daily trade. Yet the demand fueling the market is generated in developing areas worldwide.

Until recently, the U.S. only indirectly impacted upon the international determination of price.

In the past, the only effect came from how much the American market imported from elsewhere.

For over four decades, Congress banned the export of crude oil from the country on national security grounds.

Those restrictions resulted from the Arab oil embargo boycott of the U.S. during the 1973-74 Arab-Israeli War.

Today’s situation, where America has huge domestic extractable reserves of shale and tight oil, combined with significant improvements in production efficiency, has turned those security concerns obsolete.

There’s also the simple fact that no producing country in the world (with the possible exception of Iran, for political reasons) can afford not to sell to the U.S.

As a result, as part of a budget reconciliation two years ago, Congress lifted the ban on crude exports.

American refineries by that point were already leading the world in the export of processed oil products.

What followed was a quick move of American crude oil production back into the market…

Despite the Hurricanes, Oil Exports are Breaking Records

Exports had risen to a 1.1 million barrel a day level by the time Hurricane Harvey hit the Texas coast.

The hurricane slashed exports 60 percent. Refineries were also taken off line.

That combination should have pulverized crude oil prices, at least if you listened to the so-called “experts” on TV.

But that didn’t happen.

Instead, what happened next was nothing short of astounding.

Exports swiftly returned. Record levels were reached in each of the last two weeks.

As of last Friday, the U.S. was exporting 1.98 million barrels a day. The rising level of American volume in the broader market now has an impact on global price and the saliency of the OPEC-Russian agreement limiting production.

Because remember, U.S. production is not a party to that agreement.

The rising spread between WTI and Brent has also served as an additional inducement to increasing U.S. exports. The more international Brent prices have been increasing quicker than America’s WTI.

The difference, calculated as a percentage of WTI (the more accurate way of doing this), has now averaged more than 10 percent for the past 30 consecutive daily sessions – something that has not happened in over six years. Related: OPEC Producers Unmoved By U.S. Shale Threat In Asia

The advantage to American producers is simple. Exporting oil that costs less to produce at home into markets were the oil price is higher is a direct route to improving bottom lines.

As long as this situation remains, there will be additional U.S. production coming, because it’s profitable to extract and export.

And the more U.S. oil is exported, the less immediate effect higher production here has on domestic prices.

But this is also resulting in changes to foreign expectations.

Some of these are having spillover effects in other quarters…

Including sending Saudi Arabia and Russia into each other’s arms…

At least for now.