31 July 2020

Crude Oil – Sweet Spot


Crude oil price beating to the drum of global demand and risk appetite


The price of Brent crude oil has surged 123% since the 19-year low recorded on 21st April (see Figure 1), the high point in US oil inventory increases and arguably a multi-decade low in global demand, trade and GDP (the latter contracted by an estimated 3.4% quarter-on-quarter in Q1 and materially faster in April).

Figure 1 Figure 2
Source: 4X Global Research, investing.com Source: 4X Global Research, Energy Information Administration, investing.com Note: * Million barrels per day; ** West Texas Intermediate (WTI) is US benchmark for oil prices

This sharp oil-price rebound has been driven by i) a gradual recovery in global economic activity, as proxied by the rise in US demand for oil (see Figure 2); ii) OPEC+ oil-supply cuts which took effect in April and were extended in early June; and iii) the recovery in global risk appetite as measured by the rise in global equities (see Figure 1) and speculative positions in crude oil (see Figure 3). Unprecedented fiscal and monetary policy stimulus, including the Federal Reserve’s ample provision of Dollar liquidity and widespread central bank policy rate cuts and quantitative easing, and greater opportunities for households to spend have underpinned these bullish trends.

Since early July, the price of Brent crude oil and TWI has been stable around $43 and $40.5 per barrel, respectively, underpinned by the rise in US weekly demand for oil products to a 16-week high of 18.5 million barrels/day (week to 10th July) and upturn in global risk appetite. However, there are signs that world economic growth and trade remain hampered by the stop-start unwinding (and in some cases re-tightening) of national lockdowns and social distancing measures in the US and other countries in Asia-Pacific and Europe facing local or state-wide resurgences in covid-19 cases.

Figure 3 Figure 4
Source: 4X Global Research, CFTC Commitment of Traders, investing.com Source: 4X Global Research, Saudi Finance Ministry


Rise in crude oil price has eased pressure on Middle East budgets and currency pegs…

However, the rise in Brent crude oil to only $15/barrel below its 2015-2019 average (about $58/barrel) and commensurate rise in the $-value of crude oil exports have eased the pressure on the budgets and central bank FX reserves in Middle East countries, including Saudi Arabia and the UAE, and seen local equity markets rally strongly.

In the face of falling oil prices and government revenues which shrank about 22% yoy in Q1 the Saudi government announced on 10th May a tripling of the VAT rate (to 15%), which came into effect on 1st July, and a suspension (as of 1st June) of the cost of living allowance for state workers (see Figure 4). Moreover, with public expenditure still up 4% yoy in Q1, the finance minister has since warned of widespread spending cuts across ministries. These fiscal austerity measures are unlikely to be unwound near-term, but the 40% increase in crude oil prices in the past two months may negate the need for a deeper fiscal retrenchment.

Saudi Arabia’s FX reserves fell by about $8bn in March-April, if the reported $40bn transfer to the sovereign wealth fund is excluded, but increased by about $675mn in May to $449bn (a sizeable 25 months of imports of goods and services) and likely rose at a faster pace in June (see Figure 5). The UAE central bank’s FX reserves fell about $14bn between February and May to $96bn but likely stabilised or rose slightly in June. Put differently these central banks likely did not have to dip into their still sizeable FX reserves in June to keep their currencies pegged to the Dollar at a fixed rate.

The Saudi and Abu Dhabi equity markets underperformed the S&P 500 between 16th March (the Tadawul All Share index cycle low) and 21st April (the cycle low in crude oil prices) by about 4 percentage points and have further underperformed since (see Figure 6). Nevertheless, the Tadawul All Share index and Abu Dhabi Securities Exchange ADX General Index have risen 14.3% and 10.7%, respectively, since 21st April.

Figure 5 Figure 6
Source: 4X Global Research, Central Bank of the UAE, Saudi Arabia Monetary Authority Note: *$40bn was reportedly transferred to the Saudi Sovereign Wealth Fund in March-April 2020 Source: 4X Global Research, investing.com

Moreover, daily realized volatility in the price of Brent crude oil, which fell in the wake of OPEC+ countries agreeing to oil supply cuts on 9th April, has since come crashing down to levels prevailing in late-January (see Figure 7). These far more “orderly” daily moves are all the more remarkable as volatility in crude oil prices (unlike volatility in global currencies and S&P 500) spiked far higher in March 2020 than in 2008-2009, a global financial crisis which had only a limited impact on international supply and demand.

… and still modest oil price a net positive for rest of the (oil-dependent) world

Recent developments in crude oil prices are more often than not couched in terms of their impact on oil-exporting countries and companies. There has been little discussion of how the historically modest price of crude oil will benefit the vast majority of countries which are net oil importers, by easing the pressure on their trade and current account balances, central banks FX reserves and ultimately currencies. For example, these include all Asian economies bar Malaysia (a large net exporter of oil and gas). Moreover, many energy-dependent industries and companies (e.g. airlines) should profit from lower fuel prices, even if they are unlikely to fully reap the benefits at present due to the weakness in global demand. Finally households are already benefiting from a material fall in the cost of energy and fuel-pump prices.

Figure 8 shows that historically global GDP growth has been at its strongest when the crude oil price has been modest (in 2004, 2006-7 and 2010), rather than very low or high. So while the IMF forecasts that global growth will contract 4.9% this year, a modest increase in crude oil prices from current levels would be compatible with robust GDP growth in 2021 and beyond.

Figure 7 Figure 8
Source: 4X Global Research, , investing.com Source: 4X Global Research, IMF, investing.com


Uncertain outlook for crude oil prices

In the current global economic, financial and geopolitical context the outlook for the crude oil market, including prices, remains uncertain. Should governments opt for targeted measures to contain covid-19 and global economic activity continue to pick up in coming months, demand for crude oil may rise and push its price higher. Moreover, President Trump may be inclined to pump prime the US economy and equity markets in the run-up to the November elections, which all other things being equal would support crude oil prices. However, the recent decision by OPEC+ to taper oil production cuts by over one million barrels a day, as of August, could present a downside risk for crude oil prices. If this increase in OPEC+ oil production coincides with a downturn in global demand triggered by wholesale lockdowns of major economies, the fall in crude oil prices would likely be even greater.


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