A year ago, the oil market was reacting to a political bombshell and anticipating a momentous OPEC meeting. Today ... well, you could say much the same. Instead of a surprise U.S. presidential election, this week's upset is a Saudi Arabian power grab of a very different sort. And OPEC will, of course, meet at the end of this November, too.
The one big difference: expectations.
The oil market didn't really know what to make of President Donald Trump's election. In any case, that was overshadowed by a fear that OPEC's meeting, scheduled for later the same month, would end in deadlock. The prevailing mood was, therefore, skepticism mixed with confusion and a dash of optimism.
So when OPEC, helped by Russia and a few others, delivered an agreement in Vienna to cut supply, the market rejoiced:
A year on, Brent crude is, after another bout of angst, back above $60 for the first time since July 2015. The Vienna Group's supply cuts have helped to drain some of the glut, a process helped along by economic growth and, in recent months, the aftermath of Hurricane Harvey.
This November, far from being skeptical, investors broadly expect that when OPEC meets, it will not only preserve its agreement but extend it through the end of 2018. This assumes implicitly that Russia and other non-OPEC members are also a lock; a remarkable addition to conventional wisdom that also underlines how frayed OPEC's authority is these days.
Investors' optimism is quite evident in speculative positions:
The positioning of U.S. exploration and production companies is different from a year ago, too. Recall that OPEC's decision to cut supply threw the sector a lifeline by juicing oil futures to a level that let E&P companies hedge their 2017 production and thereby keep growing.
The forward "strip" now trades at $57 a barrel, above the $50-55 level that serves as an apparent threshold for E&P companies to lock in hedges to support more drilling and fracking. And again, positioning in oil futures suggests they are taking the opportunity to do so. This chart shows the net position of swaps dealers in Nymex WTI contracts, a proxy for what E&P firms are doing. The shorter the net position, the more hedges are in place:
The risk OPEC runs, of course, is that cutting its own supply to raise prices encourages U.S. producers to step in, take share, and cap the rally.
On that front, OPEC has had some encouraging news, in the form of several large E&P companies pledging to spend within cash flow, or close to it, under pressure from investors. The surge in equity issuance that helped tide the sector through the worst of things in 2015 and 2016 has slowed to a trickle since January.
And yet, high-yield bond issuance has come roaring back, and the best-performing E&P stocks in the past few weeks have almost invariably been those with high debt burdens and leverage to oil prices, such as California Resources Corp.
And while E&P companies have been chastened by the past couple of years, many have also drawn something from the experience. OPEC seemed to acknowledge as much with sharply revised forecasts for tight-oil output, published Tuesday.
The day after, Bakken-shale bellwether Continental Resources Inc. outlined plans for double-digit growth next year, without outspending its cash flow and assuming an oil price of $50-55. ConocoPhillips delivered a similar message at its strategy update the same day. When I caught up with CEO Ryan Lance afterwards, he had this to say:
Are the efficiency gains done? No. Are they less than what they were two, three, four years ago? Yes. But the whole data analytics, the technology ... I think the running room as we look at our portfolio -- and we try to gross it up for the macro -- there's still a lot of running room; lot of depth; lot of resource. And certainly the resource gets more challenged at $30, $40 [oil price]. But at $60 and $70, there's a lot of resource that will come out.
To back this up, it's worth noting that 2020 oil futures remain anchored at close to $50 a barrel even as near-term prices have rallied. This presents the biggest risk to speculators realizing further gains from here and into 2018. Against that, geopolitical risk is more acute now than a year ago, not just for Saudi Arabia, but Venezuela and Iran, too.
The biggest difference from last November, though, isn't politics or even prices, but positioning. We've gone from all-bets-are-off to all-sorts-of-bets having come back on. In other words, if OPEC's job last year was to rekindle optimism, this year's task is to justify it.
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