Brent crude oil plunged almost 4% from $67 to $63.50 a barrel after both President Trump and Secretary of State Mike Pompeo signaled progress in reducing geopolitical tensions with Iran in the Gulf. Iran Foreign Minister Javed Zarif’s conciliatory comments on the “bargaining table” in a NBC News interview also emboldened the oil bears to increase their speculative short positions on black gold. Zarif even confirmed that Iran would even reverse its decision to stockpile low enriched uranium if Washington resumed diplomatic negotiations and eased sanctions.
Has Trump struck paydirt in the art of the deal with Tehran? No. There is no evidence that Washington is willing to change its policy of exerting “maximum pressure” on Iran’s oil exports, which have now plunged to a mere 400,000 barrels a day. However, the Pompeo and Zarif interviews suggest a de-escalation in recently elevated geopolitical risk, the reason crude oil prices fell 4% from recent highs.
In retrospect, crude oil futures were a sell at $60 on West Texas Intermediate even without the US-Iran thaw. Hurricane Barry did not cause any real damage to the Gulf of Mexico’s offshore oil and gas infrastructure. The 1.3 million barrel a day disruption in Gulf of Mexico oil production has now come back online. An outage in Venezuela and Chairman Powell’s projected interest rate cut at the July FOMC had combined with geopolitical risk in the Middle East and the threat from Hurricane Barry to Gulf of Mexico oil and gas platforms to cause a frenzied rally in oil prices in the last two weeks. Yet Iran tensions and Hurricane Barry are no longer a tailwind for the oil bulls.
Tuesday’s sharp fall in oil prices could presage a major oil bear market. Saudi Arabia and Russia have extended their 1.2 million barrel a day output cut pact at the last OPEC plus ministerial meeting in Vienna. The IEA has confirmed reported a shocking 9.5 million MBD fall in global inventories last week, mainly due to the fourth consecutive weekly decline in US stockpiles. The tightening wet-barrel market in Houston definitely anchors sentiment on West Texas crude’s near term prospects and the Saudi-Russian pact could even cause a supply deficit of at least 600,000 barrels a day as summer temperatures escalate in the US and Europe. This will anchor West Texas at 54 – 56 and Brent crude at 62 – 64 in July.
However, I expect crude oil prices to fall this far more significantly this autumn. Why? One, the latest OPEC Market Report projects non OPEC supply (US shale from the Permian Basin in Texas!) will surge by 2.4 million barrels a day while demand growth will be a sluggish 1.14 million barrels a day. Two, India’s shadow banking crisis will gut its credit financed consumer spending binge and China’s $12 trillion economy is the most leveraged financial casino in human history. China responded with a tsunami of credit creation sanctioned by the Politburo. Banking assets surged from $9 to $41 trillion – I repeat $41 trillion in the Middle Kingdom in the past decade. What happens to crude oil prices when China and India, faced with systemic banking crises/a credit crunch, plunge into recession? This macro scenario is not remotely reflected in Brent crude prices now. Yet, mark my words, it will be this autumn of global risk aversion, the reason I am long the Halloween trade.
Three, if Brent falls below $40 by December, countries like Russia, Algeria, Nigeria and Iraq will seek to abandon their OPEC plus quota ceilings. This will put a disproportionate burden of the output cuts on Saudi Arabia and its OPEC allies Abu Dhabi and Kuwait. Yet Saudi Arabia just announced the most stimulative State Budget, a trillion Saudi riyal spending bonanza, since the early 1970’s. What if Saudi Arabia refuses to play the role of OPEC’s swing producer and refuse to sacrifice hundreds of billions in petrodollar revenues to maintain OPEC unity? If Saudi policy changes, as it did in 2014 under Oil Minister Ali Al Naimi and in 1986 under Ahmed Zaki Yemani, expect a replay of the 2015-16 oil price crash once again.
Four, there has been a surge in pipeline construction from the Permian Basin to the US Gulf Coast oil port terminals in 2018-19. This could lead to another shale oil output surge from the Permian Basin as pipeline capacity constraints ease. Net net, the world’s marginal price for a barrel of oil will be priced in West Texas, not Saudi Arabia. Demand for OPEC crude could well fall to 29 MBD next year. The US shale oil colossus could well produce 14 MBD in 2021. This means even if Saudi Arabia continues to play the role of OPEC’s swing producer, the kingdom’s output cuts will not be able to prevent an oil glut and a fall in Brent crude to $35 a barrel. My macro crystal ball is positioning for a major short in crude oil prices after the Fed’s July 31 interest rate cut if strong US data forces Powell to go neutral.