Oil prices were revived in December by the OPEC+ deeper cuts and the promise of trade deal but the oil market narrative for most of 2019 was pessimistic along with conventional wisdom gloom-and-doom forecasts for 2020.
We took mostly a counter consensus view of oil markets with a summer forecast of more bullish prices as well as an important call that the OPEC+ group would take bolder action with deeper cuts at its December meeting.
On this second day of January 2020, we present Hedgeye’s top five catalysts for oil markets for the upcoming year and again take several views that are counter to current conventional wisdom on key points.
1 - OPEC Will Extend Deeper Cuts at Special March Meeting
Since early December, oil prices have climbed 5 percent for Brent and 9 percent for WTI on the heels of the OPEC+ announced deal of deeper cuts for the first quarter of 2020. Russia agreed to the deeper cuts in exchange for a condensate exclusion and a special March meeting to review oil markets and the new policy.
The ink was not dry on the deeper cuts deal when conventional wisdom had already started to declare those cuts would be dialed back or ended altogether at the March 5-6 meeting.
However, our analysis is that the deeper cuts deal will be extended at least for another 3-months and be reassessed at the June OPEC meeting. Saudi Arabia and OPEC decision-making in December have finally had the desired impact on oil prices, and we believe they are unlikely to do anything in March that will undo the upward trajectory in oil prices.
Our only caveat would be that if oil prices begin to overheat, Saudi Arabia will come under pressure from President Trump and the US to dial back the cuts, especially in an election year. But Brent would have to approach $80 for us to see this happening and several red states and some swing states (Pennsylvania, Ohio, New Mexico) will benefit from higher prices.
We also strongly disagree with an emerging consensus view that Russia will exit the OPEC+ group in 2020 amid differences about production cuts with Saudi Arabia and its OPEC partners.
Much of these prognostications are fueled by comments made by the Russian energy minister late last year that the production cut deal will end at some point in the future. While the Russian minister’s comments are likely true, the timing for the end of OPEC+ cuts is not any time soon. In our view the comments are similar to past statements and made for domestic political consumption.
The big picture is that Saudi Arabia views Russia’s participation, as one of the world’s top producers, in the OPEC+ group as critical to market sentiment and any exit would result in bearish implications. We also think President Putin enjoys the important status for Russia on the world stage as a co-manager of oil markets with Saudi Arabia. For these reasons, we see no Russia exit in 2020 from OPEC+ participation.
2 - Impending Trade Deal Will Translate Into Bullish Demand Forecasts
We think 2020 will flip the script on demand forecasts that followed a weak narrative in 2019 due to the ongoing trade battles between the US and China. Recent comments by both President Trump and Chinese officials seem to be on the same page pointing to a phase-one deal likely to be signed in January.
Whatever your view of the trade deal, it will surely provide relief to the market narrative that has weighed heavily to depress oil demand forecasts in 2019.
We think a phase-one trade agreement will result in more bullish forecasts for oil demand but at the very least will end most prognostications of weaker demand.
It’s also important to note that despite the forecasts in 2019, actual oil consumption remained quite strong throughout the year. Bullish sentiment from the initial trade deal will build on the actual consumption data to provide strength to oil markets in 2020.
3 - No Trump Deal with Iran in 2020 That Adds More Oil to Global Markets
President Macron of France spent considerable time during the UN General Assembly in September to arrange a Trump-Iran meeting in New York but the effort failed for the same reasons that remain unchanged today.
But the Macron initiative, and prodding by other EU nations, as well as the US-Iran exchange of detainees late last year is fueling significant speculation and indeed predictions that a Trump deal with Iran is in the works.
We think a Trump deal with Iran is highly unlikely and certainly will not result in sanctions relief that will dump significant Iranian oil exports into global markets.
While we agree that Trump would gladly take a deal that was one inch better than the Obama deal, Iran’s insistence of lifting oil sanctions as a precondition to talks is a non-starter for the US Administration.
Moreover, Iran’s answer to Trump’s “maximum pressure” policy is a “maximum chaos” strategy in the region that has resulted in attacks on oil tankers, Saudi Arabia’s oil processing facility and now apparently the US embassy in Iraq.
Iran is calculating that Trump’s reluctance to military intervention will bring him to the negotiating table to make concessions amid the ratcheting up of attacks and military maneuvers. But we are hearing about increasing concern about Iran from inside the administration. In addition, Trump political advisors are weary of the President looking weak in an election year to Iran’s provocations. All of this adds up to continued Iran “maximum chaos” activities and no Trump deal with Iran that adds more oil to global markets.
4 - Rising Geopolitical Risks Start To Impact Prices Post-Trade Deal
The US-China trade war dominated oil markets in 2019 and resulted in a collective yawn amid attacks on oil tankers and the world’s largest oil processing facility in Saudi Arabia.
In normal times, oil markets would have priced in some impact of impending geopolitical risks but 2019 kept the focus almost exclusively on the trade narrative.
We think geopolitical risks and events will have much more of an impact on oil prices in 2020 after an easing of trade tensions that benefit both Trump in an election year and China seeking to jump start economic growth.
Moreover, we continue to see geopolitical risks increasing in 2020, including:
Iraq – A political crisis that has seen the government resign, violent protests and continued Iran intervention have now made Iraq a major concern for oil markets that did not exist four months ago. Iraq production has continued to grow despite its commitment to curtail production within the OPEC deal but the growing instability is a threat to oil production. Any major disruption in Iraqi oil production would result in major price spikes in our view.
Venezuela – We don’t see any signification Venezuela production or exports coming back online in 2020, and this will only change with new political leadership. There is an emerging conventional wisdom that Maduro will continue to hold onto power in the new year but we don’t align with this thinking. First, even Maduro political allies in Venezuela have started to openly discuss new elections in exchange for lifting of US sanctions or unfreezing personal assets. Second, Trump will come under increasing pressure in the Cuban and Latin America communities in Florida and other states to take tougher action. There is a concern among some Republican officials in Florida that Trump may have over-promised regime change in Venezuela and any retreat from that policy will create major political problems in a must-win state in the election. We are not forecasting any military action but we do not see the Trump Administration accepting Maduro as the status quo.
Iran – As we discussed above, we don’t see a Trump deal with Iran in 2020 so it means a continuation of US oil sanctions and a corresponding Iranian “maximum chaos” strategy in the region that it hopes will get the US to the negotiating table. The attack on the Abqaiq oil processing facility in Saudi Arabia was a previously unthinkable action but it expands the possibilities for geopolitical mischief in 2020. Therefore, with no change in sight, we think an escalation is more of a probability.
5 - US Presidential Election Most Consequential for Energy Markets
Energy policy will be one of the most defining and consequential issues of the 2020 Presidential campaign. Nearly all of the Democratic candidates running for President have policies that would ban hydraulic fracking on federal or private lands or both. Indeed all of the current Democrat candidates are far to the left of former President Obama or Hillary Clinton on oil and gas and environmental issues.
Certainly a ban on fracking on federal lands can probably be accomplished via an executive order and potentially impact about a third of US production. A complete ban on federal and private land would need congressional action but a new Democrat President will likely implement new regulations and rules that would make production tougher and/or more costly.
The aggressive anti-fossil fuel policy positions among current Democrat candidates are designed to play to Democrat primary voters but the nearly universal rhetoric risks making it the policy of the Democrat party.
While it is possible there will be an attempt to dial it back to the middle road for the general election, you can be sure that Trump will highlight and contrast these positions in the 2020 campaign.
We are not forecasting the winner of the November Presidential election but if the Democrat candidate appears to be winning in late October or wins on election day, energy markets and equities will head into bearish territory.
