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OPEC+ has announced plans to scale back oil production by a larger-than-expected amount. The move is intended to raise crude prices, which have fallen about US$40 since early June. Greg Bonnell speaks with Hussein Allidina, Head of Commodities at TD Asset Management, about why he believes oil has higher to climb.
Greg Bonnell: Oil has been on the rise after dipping below $80 a barrel just last week. But with concerns about slowing growth, how will this tug of war between tight supply and potentially weak demand play out? Joining us now for more, Hussein Aldana, head of commodities at TD Asset Management. Always a pleasure to have you.
Hussein Allidina: Thanks for having me.
Greg Bonnell: Me. Let’s start with what we heard from OPEC this week. And the drama continues to build because, of course, the White House not all that happy with OPEC’s did. Walk us through it.
Hussein Allidina: So OPEC met yesterday in Vienna and they announced a 2 million barrels per day production cut, which I think was larger than clearly the White House wanted, and I think a little bit larger than what the market was anticipating relative to their actual production levels. Many of these countries were not producing at the target levels. We’ve talked about the issues around spare capacity. The actual cut is probably in the tune of 800,000 barrels a day, which I’ve realized is is concerning given where inventories are. Inventories have drawn meaningfully over the course of, you know, frankly, since the pandemic lows. And they continue to draw, demand, we know, into the fourth quarter increases seasonally. We’re kind of in a trough period right now where we’re not driving as much, not heating as much as we move into November and December. Demand should increase there. The concern or maybe what keeps me up at night, Greg, is obviously the macro, depending on how bad economic growth gets, you know, the impact that that’s going to have on oil demand is is, you know, a concern. But ultimately, when we look at kind of balances, balances are tight and continue to draw meaningfully.
Greg Bonnell: The White House isn’t happy, as we said. What can they do about it at this point? Maybe they’ve been tapping the strategic reserves for a while now. At some point, I have to imagine that plays itself out.
Hussein Allidina: Yeah. So if we look at, you know, the Biden administration in March of this year announced that they were going to draw the equivalent of about a million barrels a day out of the SPR. If we look at conventional inventories, ignore the SPR, the picture doesn’t look so bad. But when you actually look at the total picture and you look at what’s been coming out of the SPR, inventories are sitting at remarkably tight levels in the US. You know, to your question, what could OPEC or what could Biden do? He could potentially announce a continued drawdown from the SPR. But we are getting to levels where, again, it’s quite concerning. You know, there are some discussion about relaxing sanctions on Venezuela. Those stories yesterday that came out that the White House is potentially considering relaxing sanctions on Venezuela to allow Chevron to increase production there. The truth is, you’re not going to be able to get a supply response immediately. So it’s a bit of a pickle, frankly.
Greg Bonnell: You brought some great looking graphs along. We just showed the audience, the US inventory ones when we were talking about the strategic reserve and what they’ve been up to. What about production levels out of the States? I mean, if the states isn’t getting the production it wants from the other side of the world, what about this side of the world?
Hussein Allidina: So early this year, you know, analyst estimates were that U.S. production was going to grow by a million plus barrels per day from start to finish. If you look at the chart that’s up there right now, we’re up five, 600,000 barrels a day. And again, this talks to the shortages of labor, the shortages of material, as well as the desire for, you know, many investors to not see companies grow production because of ESG issues. So, again, I don’t… If we look at sort of supply and demand, whether it’s in the US or globally, the fundamental picture is extremely tight and continues to tighten. You know, I think the only reason that oil is trading at 80, 85, $90 a barrel and not higher is because of this concern around what tomorrow brings. You know, if you see a material contraction in economic activity, that is going to play into weaker oil demand. However, when we look at the history of oil demand, there’s only a couple of occasions in the last 50 years where demand has declined in absolute terms, and that is around, you know, the pandemic, around the financial crisis. And then earlier in the early eighties, around the Iran-Iraq war, in the mid seventies, around the Arab oil embargo. You don’t have… If you believe in GDP growth, you have to believe that oil demand is going to increase because it is that oil that is firing, that that GDP. This chart, if viewers can see it, is U.S. supplied oil demand. It’s in the average range of where we’ve been for most of the year, weaker than it was in 2019, but not, you know, not capitulating. And I think without capitulation in oil demand, our inventories are headed to precariously tight levels.
Greg Bonnell: Now, once you really get into the oil trade and you understand that terms like contango, backwardation, start getting thrown around, walk us through this next picture. What is it showing us?
Hussein Allidina: Yes. So this is actually super, super important, I think, particularly for commodity investors. So backwardation is the term that is referred to when the forward price of whatever commodity you’re looking at, today we’re looking at oil, when the forward price is trading at a discount to the price today. Today the price is trading at a premium. So notwithstanding the fact that the flat price, the price that you see on the screen has come off from the 100 plus that we were at in the summer, the backwardation in the market has remained as pronounced. Refiners, those that actually consume oil to make the end product that you and I consume, are still willing to pay a material premium to have that oil today, vis à vis waiting till tomorrow or next month when they can get it at a discount. This underscores the tightness in the market. If inventories were not tight, if inventories were not drawing, you would see that backwardation fade and potentially move into contango. Ultimately, that backwardation has stayed as pronounced, if not more pronounced, which again, underscores how tight the balance is.
Greg Bonnell: All right. This last picture to show the audience, walk us through what it’s showing to us, sort of some of the speculative plays in the oil trade.
Hussein Allidina: Yeah. So so again, worried about economic activity as we head into the fourth quarter and into 2023. But if you are constructive oil, like I am, the fact that speculative length is at very low levels is encouraging. You have seen a tremendous sort of withdrawal of the market from noncommercial participants. The fact that spec length is low is, I think, encouraging, at least from my view, where I do see oil prices moving higher.
Greg Bonnell: So in terms of the greater risk, we touched on some of them. Obviously what OPEC recently did, how the White House is unpleased. What about the Russia situation in terms of their supply of crude to the world?
Hussein Allidina: Yeah, very good question, Greg. So if you look at what’s happened, clearly Russia is sending less natural gas to Europe. But if you look at the high frequency data, Russian exports of crude oil this year have actually been higher than they were in 21. December 5th is an important date because that is when we’re supposed to see sanctions on Russian crude. It hasn’t happened yet. If I think about the kind of the checklist of things between now and kind of where we’re heading, the Russia situation is either flat or positive for oil price because you’ll either see the same amount of crude if you’re a box and doesn’t, you know, import or you’ll see less. When you look at the SPR that we talked about, those sales end conveniently around the midterms in the US, that’s been a million barrels a day of supply that’s come out of strategic reserves available to the market. That’s ending. Seasonally, my demand increases as I move into the fourth quarter. We talked about that at the start. China has been largely absent from the market. This year, implied demand in China is weaker than it has been at any point since 1991. If China reopens, imagine you see incremental demand from China. So the catalysts, you know, the list of things that are positive for oil are definitely longer than the lists that are concerning, which is, again, economic activity.
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