Brent crude was grossly overvalued at 124 in June and black gold has come down as supply angst is replaced by the very tangible reality of a China where 7% GDP growth is not going to come back for the rest of the decade. Thus demand destruction in the petroleum products market is inevitable.
At $85, Brent is now below its level when the Russian Federation invaded Ukraine. It is significant that recession risk and a wet barrel glut triggers a tsunami of selling in the crude oil futures/swap markets even though Putin made a nuclear threat against the West and ordered mobilization for the first time since WWII.
OPEC+ has been unable to prevent the fall in oil prices since June despite its symbolic 100,000 barrel output cut. Saudi Arabia does not want to act as the swing producer in OPEC, the central bank of oil since it knows that quota discipline breaks down in an oil glut and a Darwinian price war then becomes the end game. This is exactly what happened in June 2014 when Chinese demand sagged and April 2020 when the Covid virus hit the global economy.
The Powell Fed’s aggressive monetary tightening and King Dollar’s rampage in the currency market has also reinforced the power of the oil bears. Only an utterly clueless Dr. Pangloss will now deny that a hard landing is not imminent and the laws of economics are not repealed in the Gulf, whose growth rates will be slashed as oil plummets below $60 this winter. I have learnt the hard way that bear markets in crude oil can be as protracted as they are vicious in magnitude. So Brent fell from $115 in June 2014 to $28 in February 2016. Brent tanked from $148 in July 2008 to below $40 in December 2008 as global recession and a credit market ice age killed demand. Will there be a Santa Claus rally in risk assets? Dream on.
The plunge in Dr. Copper in the past month and alarming rise in correlation between Brent crude and US equities also tell me that crude oil is yet to be priced for a global recession – but it soon will be. This is the fourth consecutive weekly loss for oil prices and something is dangerously wrong in a world where the price of Brent crude can plunge by 5% in one trading session. The existential reality of the global oil market since its earliest gushers erupted in Baku and West Texas is that its default condition is an oil glut and not an oil shortage. This is why John D Rockefeller created the Standard Oil Trust to prevent an oil price crash. This is why the corporate chieftains of the Seven Sisters managed pricing and production in the oil market in the postwar era until the October 1973 Arab-Israeli War. This is why OPEC’s swing producer Saudi Arabia cut oil output to prevent a price war during an oil glut.
Now Russian oil is available at $30 to $40 below global benchmark prices as global recession kills oil demand amid Fed tightening and epic highs in King Dollar. Crude oil will continue to fall in a classic bear market. Stay short the Brent 124 trade!
Also published on Medium.
