by Ryan Fitzmaurice, Senior Commodity Strategist at Rabobank
- The White House is playing the political blame game with respect to high gasoline prices
- Several key agencies, including OPEC, are now forecasting oversupplied oil markets in 2022, but don’t assume oil prices will fall even if this is the case
- We are expecting a surge of new capital into commodity markets in 1H22, following a stellar year for the alternative asset class as well as the CTA trading community
The blame game
Oil prices fell on the week as the rally appears to be losing steam, but not for the reasons being discussed by the White House. In fact, oil prices have been trading mostly range bound to lower ever since late October, when the year-to-date highs were set, as a combination of bearish seasonal patterns and speculative liquidation take hold.
However, even though oil futures have been falling recently, the rhetoric out of the White House has only increased, highlighting the political vulnerabilities arising from high gasoline prices.
First, President Biden put the blame squarely on OPEC and Russia, who according to him were not increasing oil production fast enough to calm prices. In our view, this statement was largely unfounded and meant to distract voters given OPEC+ is in fact increasing production every month by 400kb/d until pre-pandemic levels are achieved next year.
At the same time, US crude oil production remains significantly below (-1.6mb/d) the pre-pandemic high watermark with little growth pencilled in for the shale industry next year. Unsurprisingly, OPEC+ did not heed Biden’s call for more oil at the last supply meeting and, as a result, the White House moved on to consider a new release of oil from the strategic reserve (SPR) and even a temporary crude oil export ban, both of which could backfire and lead to a surge in global oil prices rather than reduce them. Biden even reportedly floated a coordinated SPR release with China during his virtual meeting with Xi, but prospects for joint action remain low. Not to mention, the US and China have already been quietly releasing oil from reserves but that has had no discernible impact on prices to date as discussed here and here.
To top it off, the Biden administration is now diverting the blame for high gasoline prices away from domestic policies and towards shale drillers, ordering an official investigation into oil and gas companies for potential illegal gouging despite no evidence whatsoever to support these claims.
Flows vs fundamentals
As just discussed, oil fundamentals have been in the spotlight recently given mounting inflation concerns and the political sensitivities at play. Interestingly, several key agencies including OPEC are now calling for an oversupplied oil market in 2022, suggesting relief at the pump and at the ballot box is just around the corner. This is not how we see it, however, and our disagreement has less to do with the fundamental outlook and more to do with the idea that looser balances will result in lower oil prices as the consensus has suggested. For starters, and as we often point out on these pages, the spot price of oil is extremely flow driven and prices do not simply fall because the market is slightly oversupplied, rather a trader or algorithm, as is increasingly the case, must sell oil futures to make the price go down or vice versa on the upside.
Moreover, commodities markets and oil, have a deep and wide cross-section of market participants including commercial traders and speculators. Over time, the speculative interest has become more and more systematic in nature, relying heavily on quantitative market signals such as trend, momentum, and carry to make trading decisions rather than market fundamentals. In addition to systematic commodity funds, a once dormant group of commodity traders known as index investors have reappeared in impressive fashion this year due to soaring inflation. So, between these two groups of influential speculators, fundamentals rarely enter the equation directly. For example, a large multi-asset money manager is little concerned with OPEC signalling a modest oversupply of crude oil next year and is more interested in getting broad-based commodity exposure to diversify holdings and mitigate the impact of inflation on the portfolio level.
To understand the importance of these money flows, all one must do is look back at the first half of this year to see the impact they had on oil prices (Fig. 2). To our minds, these flows were the most important price driver at the time. Further to that end, both groups of speculators are now directionally “long” oil and, importantly, have had a stellar year for returns. As a result, we are expecting another surge of capital into commodities markets in 1H22 as intuitional money chases strong returns, thereby driving spot oil prices even higher, holding all else equal. That is not to say that fundamentals don’t matter, far from it. On the contrary, we believe strongly in fundamentals, however, the price impact is much more likely to play out on the curve structure rather than spot prices.
As such, it would not surprise us to see the oil curve structure weaken next year on the back of a build-up in inventories should the calls for a modestly oversupplied market be realized.
Looking forward, we are viewing the current oil market weakness as a function of speculative liquidation in response to bearish seasonal patterns, an increase in market volatility, and a much stronger US Dollar. Furthermore, we expect the oil rally to resume in earnest early next year as institutional capital pours into commodities following a stellar year for the alternative asset class