I did not expect the ‘no deal’ from OPEC+ largely because of the urgency of the immediate demand destruction from the Coronavirus.

In hindsight, Russia’s reaction was quite rational. What about the Saudis?While they are still the lowest cost producer, the precariousness of the political situation there (see developments this weekend) makes me believe that they have a lot more to lose from the current status quo. Russia may be at a disadvantage when it comes to cost, but after years of sanctions, it is more prepared to withstand lower prices for longer.

As a result, I see Saudisā€™ attempt to lower prices on their products as a ‘bluff’, which, if called, they will have to fold. On the long run, lowering prices can only be counterproductive for them. First of all, it will affect their fiscal balance. Second, it will reinforce Russia’s (supposed) game plan (to push US shale out of the game) and hurt US, a Saudi ally. Therefore, this is at best an attempt to gain marginal market share; it would be extremely imprudent to begin a price war.

While indeed Trump has been very vocal on the benefit of low oil prices to US consumers, the sands started shifting in 2019 as the US became a net exporter of petroleum towards the end of the year: all of a sudden, Trump started extolling US energy independence. Would the US president be eager to keep a campaign promise to end US reliance on foreign energy? If so, he would now need to balance low oil prices with the risk of the US shale oil industry going bust. Therefore, I would not be surprised if the Saudis get a call from the White House should oil prices continue to plunge and that threatens the viability of US energy production.

I think the short-term market reaction this week will be brutal, but this is very different from 2014-2016 when we had similar producers’ dynamics and oil hit $30. First, inventory build-up back then was +230mbd, today it is -1.5mbd. Second, shale was in the upswing then, while now it is on the backfoot: oil-well declines are much bigger, costs are higher, and capital is scarcer. 

I was bullish WTI at $45 last weekend partially because I expected the markets to bounce on sentiment, which they did, but more importantly, because the price reflected a demand-supply imbalance discounting a sharp drop in demand from the Coronavirus effect – there was, I thought, a decent cushion. Moreover, it is my view that either China will use the oil price drop to simply buy more oil, or that economic activity in China, being the marginal swing buyer of oil, will slowly come back – or rather much faster than in the West thanks to the actions the authorities there took to contain the outbreak.

Oil eventually hit $30 in 2016 but did not stay there long. It is much more difficult to model today the demand destruction from the Coronavirus but also there should be some marginal energy demand coming from the digital medium as all these people staying/working from home get online (ICT energy use is now more than half travel energy use, and it is growing very fast). Supply side is always easier to model, and it shows that compared to 2014, inventories are much lower, shale is largely out, and specs are short.

We should not underestimate that lack of liquidity/margin calls work both ways depending on positioning (as per gold sell-off a week ago) That means one needs to watch the newswires and trade rather than invest. That’s what I am doing.