Saudi short squeeze successful, for now

Matein Khalid

I must thank Saudi Arabia’s prince Abdulaziz for the very welcome 7% (pre-market) rise in APA Corp (APA), Marathon Oil (MRO) and Schlumberger (SLB). My three large cap stooges in the universe of black gold. The Saudi Oil Minister had sent numerous smoke signals that speculators were shorting paper oil, whose volumes are often 15 to 20 times the 100 million barrels a day consumed in the global wet barrel market. So he engineered the equivalent of a shock and awe central bank FX intervention with a surprise 1MBD OPEC+ output cut. The Saudi short squeeze is wildly successful – for now. Brent is $85 and WTI is $80. This could not have come at a worse time for President Biden’s re-election hopes and demonstrates the widening geopolitical rift between Riyad and Washington.

The OPEC move comes just on the eve of the summer driving season and the price of gasoline is a key variable in American election politics. Biden also neglected to replenish the US Strategic Petroleum Reserve (SPR) as he had promised to do at $70. This makes him vulnerable to a Republican attack, especially since he warned the kingdom of “consequences” after last October’s 2MBD cut but then did nothing about it. Above all, the OPEC+ cut decreases chances of a Fed interest rate pause at the May FOMC conclave and increases the risk of a global recession that could have a catastrophic impact on dozens of indebted, impoverished EM/frontier countries.

Saudi Arabia wanted to put a floor under oil prices since Brent is down from a post Ukraine level of $130 last June as well as assert its power within OPEC+ with a proactive output cut coordinated with Russia. This Saudi move comes just after the Chinese brokered diplomatic rapprochement with Iran in Beijing and President Xi Jinping’s state visit to Riyad. Saudi Arabia is the lynchpin of the US security umbrella in the Gulf but is also anxious to deepen its geopolitical ties with its largest trading partner China and a Russia that despite its paraiah status, still commands political leverage with the Asad regime in Syria and Iran’s Ayatullahs.

I doubt if this shock Saudi move to nudge oil prices higher will succeed. The banking crisis will lead to a severe contraction in lending at a time when oil demand is still fragile since China’s post-Covid reopening has added nowhere near the 2MBD increase in petroleum products demand that many energy economists expected. This move is also a fabulous gift for Texan shale oil drillers, led by Oxy, Diamondback, Pioneer and Devon Energy. A rise in US shale output amid a global economic slump and lower petrol demand in China is a classic formula for an oil price crash, as the Gulf oil exporters learnt the hard way in the summer of 2014.

Saudi Arabia’s latest move is designed to prevent such a scenario but the law of late cycle economics tells me that the current pop in oil prices will not last and the next big move could well be a major decline as global recession seems inevitable in Q3/Q4.