Crude oil comment – The Saudi $40/b put?

SEB - Prognoser på råvaror - CommodityYesterday Brent front mth traded as low as $43.59/b ydy morning and looked ready to dive below the Aug low of $42.23/b. The sell-off ydy morning was a follow through of the deterioration last week but it was also accompanied by a solid sell-off in industrial metals where nickel sold off close to 5% with most of the action taking place in during the Asian session.

Saudi Arabian equities rose to the highest level in four weeks in response a comment by Saudi Arabia’s oil minister stating that “OPEC and other crude oil producers are working to stabilize the market”. This attracted little attention during the early trading ydy. However, the oil price jumped 4.8% from morning low when the statement was reiterated in the flowing news ydy: “Saudi government ready to do what it takes for stable oil market” and “Saudi ready to cooperate with OPEC and non-OPEC for stable prices”. At the end of the day Brent crude was only up 0.4% closing at $44.83/b. The fairly limited gain was probably down to the fact that we have heard much of a similar story before thus it was hard to interpret what it really meant.

The Saudi $40/b put. We are pretty confident that Saudi Arabia has no plan to cut production from current level without cooperation from the other OPEC members and maybe even from non-OPEC members. It is impossible to envision that Saudi would go it alone in the face of rising exports from Iran and Iraq thus requiring double action from Saudi Arabia. If anything at all the statement could mean that Saudi will see to it that the oil price does not collapse completely into the realm of $20-40/b. However, it could actually require quite a bit from Saudi to avoid this in the face of rising oil inventories, increasing contango (spot discount to forward prices), rising US interest rates and capital costs to hold oil in storage and lastly a continued stronger USD into H1-16. Thus if Saudi Arabia now launches the “Saudi put”, i.e. no risk for Brent prices below $40/b, then naturally front month Brent crude oil needs to rise in order to balance upside and downside risks. What was very clear from the statement is that it contained no mentioning of higher prices, just stabilization. In other words there is nothing in the cards for a substantial tightening of the market and substantially higher oil prices. The oil market still needs to stabilize by itself with continued low oil prices to stimulate demand and dampen non-OPEC supply. There is absolutely no plan here as far as we can see by OPEC to artificially and substantially tightening up the market thus substantially driving the oil price higher. We are not totally confident that there is any substance and reality behind the concept of a “Saudi $40/b put”. Action and not only words will be required to drive substance into the concept.

Irrespective of yesterday’s statements we still think that the oil price has a challenging time ahead as we move into H1-16 weakness with rising stocks, higher contango and a likely stronger USD.

Iran’s oil minister Bijan Namdar Zanganeh yesterday displayed little belief that there was any strong intention behind the statement. However, he did reiterate that OPEC has a responsibility for oil market stability. Again no mentioning of any responsibility or action regarding the price level. This resonates well with statements by Saudi earlier that “we don’t control the price level”. OPEC can in other words help to dampen too violent swings in the oil market, but not the oil price level itself which will have to be found through a continuous price discovery in the market place in the face of improving and changing extraction technology, competition with other fuels, changing demand growth and supply investment cycles.

OPEC meeting Dec 4 in Vienna. We expect to see more statements and speculations surrounding OPEC as we move closer to the December 4 OPEC meeting in Vienna. We expect no change in strategy even though many members whish for a higher price. “The market has to rebalance by itself” will be the strategy as far as we can see.

This morning the Brent crude price is up another 1.1% to $45.3/b along with a somewhat softer USD and some recovery in industrial metals. News of a military jet crashing in Syria is a reminder that there is still substantial risk in the Middle East.

Bjarne Schieldrop
Chief analyst, Commodities
SEB Markets
Merchant Banking

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