Oil Fails to Rally Again and 'Drill Baby Drill' Won't Change Things
Brent oil is averaging close to $70 per barrel (BBL), which has been its low going back to 2021. Since its massive rise to $135 per BBL in March 2022, it has been going down, making lower highs each time trying to rally but failing to do so, and heading back down to its $70 magnet.
Most analysts say that oil is the cheapest commodity out there and so they keep pushing it as a buy. This argument is based on a host of metrics, of which underperformance versus other commodities is one. But, most importantly, the incoming Chinese stimulus is supposed to be a key. So, is oil really cheap today?
We all know that commodities do not care about fair value as such. They rely solely on the balance between demand and supply; the net balance. If this is a deficit, prices rally, and if they are in surplus, prices fall. As we saw in the case of oil back in 2020 during the COVID-19 pandemic, there was so much oil in one month that prices went down to negative.
Oil is a market that has been manipulated by OPEC+ members, namely Saudi Arabia, that has kept about 3 million barrels per day (MBPD) to 5 MBPD of oil out of the market deliberately, hoping that prices rally high enough for them to release their production slowly into the market. That was a pipe dream back during the COVID-19 reopening, but prices have been unable to rally since despite Saudi Arabia extending its voluntary cuts quarter after quarter. For now, they are eating the lion’s share of these cuts as they lose market share and revenue stream to keep prices steady and other members happy. Of course, they cannot afford to let go of the oil market as, according to their budget spend, they really need prices closer to $90 per BBL brent to breakeven. But how long can this go on?
Oil prices fell as soon as Donald Trump got nominated, for his "drill baby drill" slogan. But U.S. production is at its maximum potential for now as companies are weary to over produce more than they need to, as these are healthy profits. They are happy, as long as prices are above $45 per BBL. The issue with Saudi holding oil back, though, is that it has given other high-cost producers ample room to keep pumping. They were too eager to believe that China would come back post its COVID reopening and demand for oil would sky rocket.
In 2024, Chinese oil demand is down about $400,000 BPD, whereas OPEC+ assumed growth of $700,000 BPD plus. Something does not add up and it has to do with the secular change in China's oil demand strategy and country dynamics. Diesel demand is being replaced by other alternatives, and China has been using cheap prices to store oil. It is not as desperate to chase high prices as over the past few years. They have been getting Oil from Iran at the expense of Saudi Arabia, as the Biden administrations had kept restrictions loose when it came to Iran going into the elections.
Trump is seen as harsher toward Iran. Some presume that he will increase the restrictions on Iran, making it harder for their oil to reach the market. Even if this were to be the case, there is all the extra spare capacity with KSA sitting on the sidelines waiting to come back. At the end of the day, the oil market will not really lose barrels, but will see more of a shift of flow as such. This is one of the main reasons why the oil price is unable to rally despite World War III rhetoric or any signs of the Israel/Iran conflict picking up. There really is no shortage of oil.
If only all that OPEC+ oil were to be released into the market, allowing it to find its natural floor, then one can start talking about any sort of fair value. But, it would be nowhere near a six handle, let alone seven.
At the time of publication, Bengali had no positions in any securities mentioned.