The Trade Week Ahead – The politics of oil

The politics of oil

Trading the economic events this week really doesn’t begin until late Thursday. The ECB is deliberating on its monetary policy set ups The US has its GDP. If there is anything of note from the ECB it will be its 2019 outlook and the ‘possibility’ of it raising its lending and deposit rates in mid-winter. The issues facing Italy and the periphery make this unlikely in my view.

The trade to watch this week is oil – geopolitics could create a short call.

  • World oil is facing a geo-political crisis not seen since the OPEC oil freeze of the 1970’s. The horrific events that transpired in the Saudi Arabian consulate in Ankara over 2 weeks ago to a prominent critic of the Saudi Royal family is appalling. What is becoming more untenable is the ‘official’ response to the events from Saudi Arabia as it finally recognised his passing on Sunday – however how he died is now at version 3 and counting.
  •  The events are placing a huge amounts of pressure on a response from the White House, in fact this could be the biggest test for Trump since becoming President as this has the potential to put the entire US-Saudi relationship at risk. The President’s position on the situation has veered from one side to the other however it is clear action is need. The other risk for the President is that he has personal and political links with the Royal Family and a Mid-Term to win. Swings in WTI is the last thing he needs.
  • The Republican party however is fuming and several senators are demanding the President pressure Saudi Arabia for the truth. The UN, Europe and most of the international community are following suit. This kind of political movement is making oil markets nervous as what might international (or even just US) ‘action’ look like?

More importantly what could the response be from the Saudis to said ‘action’?

  • Last Thursday the Saudi Foreign Minister released the following statements – which gives a clear idea of what the Saudis are thinking: “The kingdom affirms its total rejection of any threats and attempts to undermine it, whether through economic sanctions, political pressure or repeating false accusations…The kingdom also affirms that if it is [the target of] any action, it will respond with greater action.” The statement closed out with this line “[Saudi Arabia] plays an effective and vital role in the world economy”. The inference is clear – we will pull our oil supply this equates to approximately 14% of global supply aka – 10.2 million barrels of oil. All this political risk suggests in the interim we could see a spike higher in oil as political ‘action’ is taken – if this transpires I see an interesting trade opportunity.
  • Removing the geo-politics, the price of oil normally follows simple economics – supply and demand. Prime example is last week, oil actually fell as US stockpiling of oil surge. The latest oil inventory figures show that the US stockpiled 6.49 million barrels of oil in the second week of October double the consensus estimate. It shows that supply is always key to oil pricing and clearly supply is ramping up. The best gauge of this is US rig count – US oil producers tend to soak up price and move rig count with price seen in this chart. Meaning as the price shifts higher more supply comes onto market which creates a price ceiling.

US Rig Count (orange) versus WTI Crude (purple)


 

  • Therefore the potential trade is actually a short off the back of oil skyrocketing on an intra-week basis from the geo-political intervention. Oil could be anywhere between US$65 and US$85 a barrel over the coming month depending on the ‘action’ taken – However supply is ready filling the price gap and will over run the spikes quickly. I suspect that if oil jumps to $85 a barrelit will slide back to current levels over the preceding few weeks. Use stops as geo-politics is unpredictable – economics is not however.

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