Since late 2022, our message has been consistent: Survive the first quarter. Unfortunately, we will barely survive. WTI fell below the critical support range of $69-71 today, putting it within striking distance of the next support level of $61-63. The reality is this the macro situation at the moment with the possibility of Credit Suisse Group AG (CS) failure is so uncertain that no one in their right mind wants to invest heavily in an economically sensitive commodity like oil.
Put another way, if you were an oil trader today and we asked you what the risk/reward of going long is, you could just point out: 1) the physical market is tight; and 2) the supply deficit on the horizon. But those aren’t catalysts for wanting to go long TODAY, and that’s the big differentiator here.
Conversely, if we ask you what the risk/reward of going short is, you might point out that OPEC+ could cut more production as a tail risk, but broadly speaking, the risk/reward is skewed to the downside.
This mindset, along with biased positioning and negative delta gamma heading, has gotten oil to where it is today. Never mind the fact that the various demand signals we look at actually point higher, perception is reality today, and perception is awful and could get worse.
This is the sad reality we face today, but in times of turmoil, we must return to what got us here in the first place. What are the basics like? How are the fundamentals of our companies? Are we positioned correctly?
Instead of focusing on the unknown, we must first understand the situation we are in and whether or not that situation will improve.
So let’s put Credit Suisse aside for a second. Let’s look at just the fundamentals of the oil market.
In the chart below, this is the IEA’s latest global supply and demand outlook.
What should be clear and obvious from this chart is that the supply side of the global oil market equilibrium is known. Most likely, global oil supplies could surprise on the downside, given the recent oil slump. Oil companies tend to weight their capex into the second half of the year, so if prices stay low in May, for example, there’s more than a 50% chance that the capex up
Based on our model, if WTI holds between $65 and $70, US shale oil production could surprise lower by ~200,000 b/d, leading to year-end output at ~12.7 million b/d. This would represent a growth of only ~350 kb/d output to output (assuming December is 12.4 due to the impact of the freeze).
The IEA currently assumes +1.1 million b/d from the US, so this number is likely to be biased downward as a result.
Note, however, that the IEA has Russia declining by about 700,000 b/d. Given what we wrote about Russia yesterday, we should assume that this loss does not materialize.
In turn, the compensation variables we see in this table above are: 1) Brazil (probably too high); and 2) the US (probably too high). Assuming these two variables offset ~500,000 b/d of the ~700,000 b/d assumption, we will be left with a net surplus balance of 200,000 b/d.
Now flipping that calculation over to the IEA’s assumptions for this year, you can see that the second half of 2023 will still show inventory draws.
Essentially, we know it’s not supplies, so the only variable left is global demand for oil.
And looking at global oil demand, you can see that we’re already on track to be well above 2022 and 2019 thanks to the reopening of China. China’s economic data so far has been encouraging, so the reopening of trade is real. The question now is whether any of the things happening in macro earth will have a contagion to the rest of the world and affect oil demand.
Unfortunately, we don’t know. Our biased view is that the banking issues are contained and unlike the global financial crisis we saw in 2008/2009. Bigger banks are much better capitalized with better risk ratios, but you don’t know what you don’t know. The problems happening at Credit Suisse have been a long time coming, so none of this was a “surprise” to the market like Silicon Valley Bank was.
But I think the biggest unknown here is that we don’t know what we don’t know. The market is now showing a 50/50 chance that the Fed will even raise interest rates next week, and they are now starting to trade on a 100 basis point rate hike later this year. Clearly the Fed has messed up and we are discovering the consequences.
so what happens I do not know. Is the bank situation contained? Logically, I think so. But is there something else we don’t know that’s hiding? Possibly, and that’s what makes this question so difficult.
But if we take a step back and just entertain the idea that oil prices remain low and that global oil demand is floundering. what happens next
I can say with a high degree of confidence that, given the limited global supply situation for the foreseeable future (post-2023), once demand recovers, oil prices will rise.
And the degree of the rise will depend on how much excess oil inventories we build in the meantime.
So is it just a matter of time? Yes. Is there much uncertainty in this path? Yes.
But that’s the direction we’re headed because supplies are going to be tight. That’s just the nature of the beast (commodities, but oil in particular).
So what am I doing with my wallet? Absolutely nothing. I don’t buy, but I don’t sell either. In times of turmoil, it is best to sit still and think. This is the path I choose.