“Within 20 years, we will be an economy or state that doesn’t depend mainly on oil“.
This critical statement from Saudi Arabia’s deputy Crown Prince has been lost in the hype surrounding Q1′s hedge fund-inspired rally in oil, commodities and Emerging Markets. There has seldom been a better example of markets failing to see the bigger picture by remaining focused on day-to-day detail.
But Q2 is likely to see attention return to the fundamentals of oil market supply and demand. This week’s commodities market data showed the hedge funds were already starting to take their bets off the table. This is hardly surprising, with prices having jumped 50% in a matter of weeks:
- Iran is successfully re-entering the market, with its exports to India already up 4-fold since January to 500kbbl/day, and other Asian countries also keen to buy
- US storage operators are resorting to ever-more desperate manoeuvres to stop their tanks from over-flowing
As I warned last month, the rally had nothing to do with a rebalancing of oil markets – either via major cuts in production, or a sudden increase in demand. Instead, it was all about the funds betting, correctly, that further stimulus was on the way from the central banks. As the Financial Times noted:
- By the end of March, the funds had built a record long position of 579m bbls in Brent/WTI
- This was equivalent to almost 6 days of global demand
But last week, they began to take their profits and close their positions. Chemical markets thus face major challenges:
- Prices for the major petrochemicals are highly correlated to crude oil prices – most are more than 95% correlated
- So sales managers are already busy raising their prices to try and maintain their margins
- Purchasing managers are meanwhile building inventory to protect their own margins
And they are not alone. The Q1 rally spread across the commodity sector, and led to major bond and share price rises for commodity exporters and Emerging Markets. But none of the move was real. It was simply the hedge funds spotting a short-term opportunity for profit, based on the realisation that another central bank panic was on the way.
So now, as one would expect, the smart funds are not hanging round to see what happens next. Of course, US oil inventories will reduce as we head into the main driving season. But fundamentals didn’t drive the rally, and the funds know all-too-well that sudden rallies can disappear as quickly as they appeared.
Attention is thus likely to turn to last week’s 5 hour Bloomberg interview with the deputy Crown Prince of Saudi Arabia. It confirmed, as I have argued for the past 18 months, that Saudi is focused on making plans for the post-oil world and highlighted, for example:
“His obsession with moving the Saudi economy away from oil…Aramco’s new strategy will transform it from an oil and gas company to an energy/industrial company”.
Companies and investors have to follow market trends, as they cannot afford to be on the wrong side of 50% rallies. But they also have to recognise that the biggest rallies always occur in bear markets. Oil’s next move may well be another 50% decline, and as I warned last month:
” If prices collapse again as the hedge funds take their profits, companies will face the risk of bankruptcy as we head into Q3. They will be sitting on high prices in a falling market – just as happened in January. Only Q3 could be worse, being seasonally weak, and so it may take a long time to work off high-priced inventory”.