China Stimulus, Middle East Tensions Force Saudi Arabia's Hand on Oil
OPEC might soon have to allow oil to return to its fair-market value.
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The OPEC+ saga around its oil price forecasts and demand assumptions certainly makes for interesting viewing. If you're bored of your regular Netflix series, this one is highly recommended, as it is filled with geopolitics, conspiracy theories, global wars and more.
For the last three years, OPEC+ has stuck firm to its commitment to keep about 3 million barrels per day (MBPD) to 5 MBPD of oil out of the market until such a time as demand rises, when they will release their oil and make out like bandits. Well, that was certainly the plan, which has not come to fruition until today. The Saudi oil minister has been known to warn speculators not to short oil, lest they wish to "bite the dust" or some other '80s phrase that he so loves to quote from time to time.
Despite their efforts, Brent oil today is trading down to its 14-year lows around $70 per barrel (BBL). OPEC+ optimism was based on an eventual oil price recovery into Q4 on China coming back. China has been a complete basket case for the last few years since their COVID reopening failed to garner excitement despite all the attempts by the People's Bank of China (PBOC) to inject stimulus to support their housing markets.
Each time, the rally fizzled out as most Western economists kept believing China would use its old playbook from the 2000s to stimulate infrastructure and growth. Its real objective is to stimulate the domestic consumer and not build more empty buildings. China has seen oil demand down by 300,000 BPD rather than up 700,000 BPD this year!
This past week, the PBOC used its September economic meeting to throw out some headlines regarding cutting the required rate of return (RRR), lending rates and lowering the down payment for home purchases in most cities, along with $150 BBL to support their local equity markets. This saw Chinese indices up 27% in just a matter of six days, causing a lot of pain among hedge funds as they scrambled to cover their shorts.
Regardless of this monetary boost, oil prices failed to react compared to copper and iron ore, which are much more sensitive to China's demand. On Tuesday, we finally saw Iran retaliate to Israel’s attacks over the past few weeks, especially after their incursion into Lebanon killing the main leader of Hezbollah, Hasan Nasrallah. For the first time in decades, Iran actually launched 300-plus long-range ballistic missiles into Israel’s Tel Aviv, some actually managing to get through the iron dome. This has seen oil prices rally 5% from the lows as Israel is now rumored to retaliate and could be planning to hit their oil or nuclear infrastructure.
Given that Iran exports about 3.5 MBPD, one would imagine oil prices would be up much more than that. This certainly is not the 1970s. Whether the U.S. will allow their ally to target oil just one month before the U.S. election remains to be seen, but it will be a tall order to prevent.
Saudi Arabia is tired of its members cheating and over producing while they do the heavy lifting with their voluntary cuts. The group has decided to bring back their production in December, delayed from June as prices failed to rally. The energy minister warned that oil could go down to $50 if cheaters do not comply, implying they could flood the market after all the years of defying the market, suggesting oil needs to be north of $100 per BBL. This just goes to show that the real fair value of oil would be around that level if it were not for OPEC+ holding back so much oil off the market.
We have opined for years that there is no shortage of oil and, given the demographics in China, alternative sources of supply and secular shifts in demand, one cannot look at China with the same model as before.
For years, Saudi Arabia has been funding the high-cost producers. Will they now teach them a lesson rather than the speculative funds? All eyes will be on Israel’s response, but just like the Ukraine invasion, it is important to keep the real physical flow of barrels in mind and keep one's emotions in check.
At the time of publication, Bengali had no positions in any securities mentioned.
