Discover more from Kaoboy Musings

KAOBOY MUSINGS and its associated podcast KAOS THEORY focus on the intersection of Financial Markets, Macroeconomics and Geopolitics. I've spent 30+ years as a trader/hedge fund manager and now manage money for my family office across many asset classes.

Over 10,000 subscribers

Re: Oil-Notes From Capital One Oil Call.

My friend Lakshmi Sreekumar, who I regard as one of the best macro oil analysts, hosted a private call today. Here are some key points.

Michael Kao

Mar 6, 2021

OPEC+ meeting “was a shock.” Especially notable: SA’s decision to roll over its voluntary cuts. With 6 months of consecutive supply draws, YE’21 global inventories will be below the OPEC+ "safety stock" target of 2.75B bbls. This has led to serious price spikes in the past.

BUT, the only reason oil is flirting with $70 now is artificially inelastic supply, as demand recovery still has a way to go before hitting pre-COVID levels of 100.6 mmbpd vs 94.8 mmbpd currently.

Jet fuel demand, notably, is still 45% off-line and will be the biggest forward driver of oil demand recovery. Most other distillates have caught up to pre-COVID levels of demand.

As I’ve been tweeting, the geopolitical shift under Biden is significant. Lakshmi agrees. Obama/Biden Admin was overtly pro-Iran; Trump Admin flipped to pro-SA. Now, Biden/Harris seems to have flipped back to pro-Iran at least rhetorically.

That said, recent actions (Syrian air strikes and enforcement of Iranian sanctions) suggest that a return to JCPOA won’t be that easy, especially with the blatant Iranian cheating on uranium enrichment.

However, SA’s decision to overcorrect on inventory drawdowns suggests that they might be anticipating a sooner-than-anticipated return of Iranian bbls anyway. SA made extra cuts in Jan to overcorrect for Libyan bbls in the same way.

Spare capacity is admittedly high. Core OPEC has 6.5 mmbpd without Iran and 7.9 mmbpd with Iran. Add in Russia and the Neutral Zone (between SA and Kuwait), and we’re at 10.5 mmbpd.

That said, there seems to be real resolve for OPEC+ to keep supply artificially inelastic, as it saw what happened when it did the opposite last year.

OPEC+ senses that the policy shifts in Biden Admin are putting the US in a “checkmate” situation, potentially setting up a vicious cycle for the consumer but a virtuous cycle for oil. Steps follow:

Fiscal stimulus is geared towards pushing $ into the lowest wealth deciles who spend a big chunk of their stimulus checks on commodities like gasoline...
BUT the “ESG/Climate shackles” put on the shale industry AND the steep backwardation of the forward curve make it difficult for US shale to ramp up production...
A simultaneous return to anti-SA foreign policy is emboldening SA/OPEC+ to make US dependency on ME imports painful, which hurts the lowest deciles of wealth...
...which potentially spurs more stimulus. Go back to Step 1. Rinse. Repeat.

Lastly, US "Joe Consumer" is just on the precipice of feeling significantly higher gasoline prices, so expect this to manifest in CPI numbers over the next several months.

Imho, this potentially creates another feedback loop for risk assets: Incipient inflation -> Steepening yield curve -> “Taper tantrum” across all “risk assets” but especially those assets that have benefited most from “negative risk premiums” (tech stocks, crypto, etc.)

As for the K-shaped recovery, the endless financial repression by the Fed via ZIRP is making the arm of the K lift higher and the leg of the K drop lower.