National Post (National Edition)
Speed bumps on horizon for oil prices
Oil prices have been on a tear over the past 12 months, rising more than 65 per cent from its US$42.50 per barrel low in June 2017 to recently breaching the US$70 per barrel level to start the week. There have been a couple of important drivers behind this rally, but looking out longer term there are also some potential speed bumps on the horizon.
On a positive, world oil demand responded in a big way to sub-US$50 prices during 2016 and well into 2017. A recent report by the International Energy Agency shows that global demand expanded by 1.5 million barrels per day last year, representing a 1.6-per-cent annual increase. This was much higher than the average oneper-cent annual growth rate during the past decade.
Noticeably, a lot of this growth came from the transport sector with a surge in larger vehicle purchases as SUV and light trucks represented nearly two-thirds of total U.S. sales in 2017, up from 47 per cent in 2011, according to IEA data. Not surprisingly, this resulted in a rebound in U.S. gasoline demand and a material improvement in once-high inventory levels. Throw in a drop in U.S. oil imports and total domestic oil inventories have fallen more than 17 per cent from year-ago levels and are now nearly 2.5-percent below their five-year average.
Looking abroad, about 60 per cent of total global demand growth comes from Asia, with China recently surpassing the U.S. to become the world’s largest oil importer. It, too, has responded to low oil prices by ramping up purchases of larger and less fuel-efficient vehicles. According to an analysis by U.S. oil security monitor SAFE, Chinese consumers purchased 10 million SUVs in 2016, a 25-per-cent increase over 2015 levels.
Interestingly, China receives most of its imports from OPEC-producing members. In this regards, Saudi Arabia is throwing everything including the kitchen sink to support higher oil prices ahead of its Aramco initial public offering. The timing couldn’t be any better for them given the May 12 Iranian nuclear deal deadline that is putting U.S. President Donald Trump in a very troubling position on whether to reimpose sanctions that would reduce Iranian oil exports, which would send oil prices even higher.
“Looks like OPEC is at it again,” Trump tweeted on April 20. “With record amounts of Oil all over the place, including the fully loaded ships at sea, Oil prices are artificially Very High! No good and will not be accepted!”
Speculators have been on this bandwagon for some time now, pushing noncommercial long positions to never-seen-before levels. Not surprisingly, some have even joined the Saudi’s pre-IPO marketing campaign, with one prominent hedge fund manager publicly calling for the possibility of US$300 per barrel oil.
The forward market for oil prices has responded to all of this by moving into steep backwardation — meaning future oil prices are much lower than current oil prices. According to a Reuters report, the current backwardation in Brent is the most extreme it has been in more than 25 years, putting it in the 91st percentile of all trading days since 1992.
Meanwhile, the U.S. dollar is not only holding steady in this environment but recently rebounded, moving higher with oil prices. This is contrary to the global reflation trade that so many have been betting on over the past year and perhaps a warning sign on the sustainability of higher oil prices.
In particular, we wonder why no one seems to be asking what happens when the euphoria runs its course and global consumers with all of their SUVs wake up to materially higher oil prices at the same time the banks are hiking their mortgage rates. And this doesn’t account for the potential supply impact from U.S. shale producers that for some strange reason are no longer considered a threat to OPEC and other non-U.S. producers.
In the meantime, upward and onward. Martin Pelletier, CFA is a Portfolio Manager and OCIO at TriVest Wealth Counsel Ltd, a Calgary-based private client and institutional investment firm specializing in discretionary risk-managed portfolios as well as investment audit and oversight services.