The only certainty an oil industry observer can bank on right now is that no one understands the markets.
The extreme end of globalization has introduced so many variables that market analysts can no longer effectively predict the non-linear ripples. Right now is a case in point. We have a clean cut dividing line between key markets analysis, with those who fear a banking failure contagion threatening oil demand, and those who say there is no systemic catastrophe and oil will be bulldozing its way back to $100 in no time.
Neither narrative can catch oil prices, however, which have had an extremely volatile couple of weeks.
Dueling Narratives
Just over two weeks ago, oil prices crashed as fears of contagion following the sudden collapse of Silicon Valley Bank (SVB) and signature bank. That was followed by the share crash at Credit Suisse, which suggested that the initial failures with small, regional U.S. banks perhaps had a global financial crisis aspect. By the week of March 20th, oil prices were clawing back some of those losses, and by the week of March 27th, we saw a major rally (on Monday, the 27th, alone, oil prices gained ~5%). Still, oil rests in the $77 range for Brent and the $72 range for WTI.
This, recession fears, and what to expect from Chinese oil demand, rule the key narratives that are so divided on what oil prices will look like for the rest of this year, and beyond.
The bulls’ camp includes Goldman Sachs, Barclays and ING. While all three have cut their oil price forecasts for this year after crude lost 10% two weeks ago, their target prices for this year run from $80-$96 per barrel.
For the bulls, it’s all about China right now, and they are fairly confident that commodities markets will be spared from the banking sector’s problems. They don’t see this as a financial crisis along the lines of 2008-2009. While Goldman revised its $100 oil price target to $94 in the next 12 months, and $97 next year, it’s still quite bullish.
“Oil prices have plunged despite the China demand boom given banking stress, recession fears, and an exodus of investor flows,” Goldman said in a note last week, as quoted by Bloomberg. “Historically, after such scarring events, positioning and prices recover only gradually, especially long-dated prices.”
But even the bulls are following the herd mentality. With their pens, big oil traders are calling an imminent oil price rally, but with their trades they are selling-off in a temporary panic because everyone else is. The bulls are betting on a long-term market rally on one hand, but on the other hand, they are taking part in the near-term sell-off.
Rebecca Babin, a senior energy trader at CIBC Private Wealth, explained it to Bloomberg like this: Traders “can still have a bullish thesis but realize surviving the next month is mission critical. Many investors are in survival mode here.”
So, they’re all rushing for the exits while predicting a bright future for oil prices, and the herd mentality takes over for all animals. Another way to interpret this is that no one really has a handle on what oil prices will look like for the rest of this year, and to be safe, they’re all playing it bearish in the immediate term.
Ed Moya, OANDA senior market analyst, calls the nature of this market “Jekyll and Hyde”, warning in a podcast cited by SP Global on Monday that while he was optimistic that oil would be spared from the banking crisis, the market could turn on a dime. Again, it’s another way of saying we find it impossible to hedge our bets on oil prices.
The Iraq Shutdown that Boosted Oil Prices This Week
Even the smallest of geopolitical ripples in the past couple of years has begun to have an immediate and sometimes dramatic effect on oil prices–even if only for a day. Analysts can no longer follow all potential scenarios to the end, causing more price volatility. Oil prices, as a result, have become immediately reactionary, typically then balancing out after markets have had time to digest a particular development.
The Iraqi decision to order the shut down of the pipeline feeding gas from the Kurdistan Region of Iraq (KRG) to Turkey illustrates well how analysts have gotten lost in the melee. At issue here is some 400,000 bpd.
That figure is only important from the perspective of the 500,000 bpd Russia vowed to remove from the market when it said it would reduce production for March.
However, at the same time that oil prices were surging on Monday on the Iraq news, Russia was backtracking to some extent on its output cut plans. Russia didn’t change its plans to cut 500,000 bpd, but it did change the figure on which the cut is based. When the plan was initially announced in February, the 500,000 bpd output cut was to be based on January production levels of up to 9.9 million bpd. On Monday, Moscow clarified further that it would be based instead on February’s output level of 10.2 million bpd.
What this means is that the output reduction will be lower than originally anticipated. In other words, oil prices were rising on the notion of taking 400,000 bpd off the market in Iraq at the same time as Russia’s 500,000 bpd output cut–even though the Russians have downgraded their cut, and no one has yet seen any indications of one.
Prior to COVID, any manifestation of something concrete in the battle between Baghdad and Erbil for control over Iraqi Kurd oil resources was largely ignored by the markets, much like they barely blinked when Libyan oil was taken off the market for years. Today, we live in a very different environment.
The market is extremely reactionary and a herd mentality has set it, making the sell-offs and the buy-ins far more dramatic. And the market volatility is circular. One outsized reaction resulting in a sell-off has a fast-moving domino effect that creates even more volatility. There is no time to digest global events before oil is crashing or surging on a whim.
It used to take an Iranian missile strike on Saudi Aramco facilities to spark this kind of reaction. Now, it only takes a small pipeline and only 400,000 bpd to cause the exact the same result.