Crude oil had a wild year in 2018. WTI went as high as $75 USD and as low as $43 near the end of the year. And these volatile price actions show no sign of stopping as the price has rallied more than 15% since 2019. And often we see the oil price is driven by headlines from Trump/OPEC/geopolitical events. This shows that news and narratives are just as important as fundamental analysis when it comes to the oil market. In this brief reading, Seismic will try to present an approach that helps identify the current oil market narratives, and see what they are signaling.
The price of oil is often times being driven by several familiar narratives that constantly rotate from one to another. And one dominating narrative that had a large impact last year was the constant talk down of oil price by US President Donald Trump. The waves of political and geopolitical comments from the White House forced Saudi to keep pumping more supplies into the marker, and the negative sentiment eventually pushed oil price into a bear market in late 2018.
Today, Seismic wants to present our findings on important narratives on oil price, the reactions on these narratives, and how they have evolved.
Since the start of 2019, the oil price has increased by more than 10%, and the consensus believe the reasons behind the price surge are:
- overly pessimism on global economy
- OPEC supply cuts
- plummeting Iran oil exports
However, we think the main driving force behind recent price actions is the OPEC supply cut expectations. The interesting thing about this expectation is, this isn’t something new. During late November and early December, when OPEC met, many expected the cartel would vow to cap production in check, and OPEC did exactly that. But oil price didn’t react to the narrative of the supply cut. So what’s the reason behind the recent refocus on supply rebalance? We think it is because the negative drag on sentiments from politics have finally faded in early January, allowing the market to shift focus back to OPEC and supply cut.
In the charts below, the topic of the chart is shown on the top of each chart. The X-axis lists stories that we picked as relevant to the topic. The Y-axis shows the change in relevance to the topic during a period of time. In the charts below, our data period ranges from October 2018 to January 2019. So for example, in chart 1, the topic is about Trump, and the stories we are interested in observing changes in relevance to Trump are listed in X-axis (Saudi/Sanction/crude..etc). As you can see from the first chart, almost all stories on oil have decreased in relevance in relationship to Trump. This gives us the confidence to believe that the political risks that weighted on oil price have finally faded, and market is ready to move on to a different narrative.
We noticed that once oil price surged during late summer 2018, Trump began repeatedly and openly attacking OPEC, saying the cartel manipulates oil price and needs to boost production. We notice this negative drag from Trump on oil price has receded noticeably recently.
Moreover, in our textual analysis model, we discover that recently political topics, such as Iran, sanctions, Trump no longer have a strong correlation with crude oil. The only strong correlation with crude is price, which is understandable because the price surge in 2019 has gained many attractions.
Also, we noticed Saudi, which has been hammered by the press globally because of the murder of Jamal Khashoggi, now has been off the radar and is no longer showing connections with crude oil.
In sum, we conclude our findings below:
- Oil market now is no longer being influenced by political events.
- After media attention on the Khashoggi murder fade, the connections between oil and politics have also dipped. So we think this is a good window of opportunity for Saudi and OPEC to continue to push for higher oil price by signaling supply cuts.
If we see further oil price increase without any interference from Trump or political noises, we believe the oil market narrative will continue to be about OPEC and the cartel’s plan for supply rebalance. Therefore we think going forward it is important to keep track of the sentiments and stabilities of OPEC members.
On the fundamental side, we think shale oil productions peaked in 2016. Shown in charts below, you can see the new well production per rig has reached an all-time high in 2016 and has declined in 2017. Despite some recovery in 2018, we expect as higher quality legacy oil fields retire, the number of production per rig will not be able to recover to prior high. In addition, we are currently in late rate hike cycle, so the cheap borrowings advantage shale oil companies enjoyed in the past several years to finance production no longer exist.
There’s an article from WSJ highlighting the problem of shale oil producers failing to meet production targets. (https://www.wsj.com/articles/frackings-secret-problemoil-wells-arent-producing-as-much-as-forecast-11546450162)
Considering that many shale oil producers have stretched balance sheets because of heavy borrowings to finance oil field acquisitions, the threats of more rate hikes credit market downturn could seriously limit fracking companies’ ability to leverage for expansions.
We expect the oil market to see more supply pressure as OPEC continue to cut productions and shale oil producers fail to meet production goals. And this should lead oil price to a stronger performance than the consensus expected.