What is the biggest trade in the markets just now? The one-way bet on European fixed income, with ECB QE set to obliterate anyone who challenges ludicrously low yields? The tech bull position, with the Nasdaq around the highs of 2000? Or could it be the brutal battle being fought in the oil market? Let’s ignore the collapse in Eurozone yields and nose-bleeding valuations in tech, and concentrate on my favourite trade – oil.
Last week, Intercontinental Exchange revealed that the hedges and specs were piling into the oil trade in levels not seen since the middle of last year (that was when crude was still at $110 per barrel, pretty much double where it is now). The longs are out in force, according to the data, but are they too early in calling an end to the oil price rout? Yes, Brent had a fantastic rally in February, having plummeted to the low $40s region. But was that just a dead cat bounce?
Despite a lot of excitement about the falling rig count and the huge number of expenditure cuts across exploration and production, there is still over-production across the world. In fact, if you believe the bears, the US will shortly run out of storage space above ground.
Guys in the industry who have seen cycle after cycle like this keep telling me that “the cure for lower prices is lower prices”. But when will we see supply and demand responses to $50-60 oil? Many wells just can’t afford to stop just yet, whether because of the need for Middle Eastern petro-dollars or the demanding Texan bank manager who still expects the oil well-related loan to be serviced.
Surely, the key factors in where we go next have yet to come to the fore. And for many, June will be the main event.
That month will see the next scheduled Opec meeting, and it is possibly the most likely time for a supply response from the group representing around a third of global production. But the end of June also happens to be the deadline for the Iran nuclear deal. If, and it’s a big if, Iran gets a framework agreement by then, it will be desperate to ramp up oil production as quickly as possible. It may take months if not years but, believe me, they really want to ramp it up.
Iran doesn’t just want to up levels from the current 2.8m barrels a day. It wants to get to the 4m barrels it was producing in 2008, and to keep going on and on and on. That will set up Iran for a huge row with Saudi over Opec production levels. But the Iran production growth story also makes factors like Libya’s piddly production oscillation and US rig count obsession pale into insignificance.
So, for me, the phoney war going on in the oil market at the moment may just result in a stalemate until the middle of the year. That is when we may get the real battle. The one that may just justify at least one side of the extreme calls – from $20 to back up to $90 per barrel.
City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.