2018: WTI oil - sentiment vs. reality

Consensus said:

Following a two month upward trend speculators and commentators were talking of oil regaining $100bp, partly due to US-Iran political considerations. 

We said:

‘Trump premium’ fuelling speculation of a quick move to $100/bbl. Fundamentals are less supportive; this is not 2007/08. 

With the margin of safety from spare capacity thinning and the market more or less in balance, the sensitivity of oil prices to shocks has become more acute. All these are admittedly ‘known unknown’ risks, but they are particularly hard to price in. Investors will therefore prepare for the worst.

With non-OPEC conventional crude supply still on the back foot, this is a mix for keeping price risks skewed to the upside, allowing speculation for a spike to $100/bbl to build. However, we would caution investors to not get carried away at this stage.

First, Trump’s oil tactics are self-defeating: a tougher stance on Iran implies higher, not lower, oil prices. Besides questions on its ability to enforce the sanctions, the US will come under pressure sooner rather than later to show some flexibility. This could take the form of offering exemptions/waivers, as has already been flagged, or simply tolerating less-than-full compliance - much like OPEC turned a blind eye to over-compliance with output cuts for a period. The combination of reduced uncertainty and a dose of pragmatism should go a long way towards bringing oil prices off the boil.

Second, purely from a standpoint of fundamentals, nothing has really changed since June. If anything, there are reasons to be less constructive on oil prices.

This year’s decoupling points to a rally that has matured. The easy gains for oil are behind us, and it is increasingly evident that the same applies to the efficiency of Riyadh’s supply tactics. Trump’s sanctions have raised the stakes, and the market is now driven by fear. But at this juncture we think it makes sense to lean against further oil price strength instead of chasing this rally.

Outcome:

WTI oil began an uninterrupted fall from $75bp at the time we published to close the year down 39% at $45pb.