Trade Deal Might Not Spark Major Oil Rally

Crude oil markets came under pressure this week as Saudi Arabia reported a full production rebound in October and traders grew impatient over progress on a US/China trade deal. Like everyone else, we’re still waiting for a deal to clear the macro skies and set the stage for a risk-on rally. However, recent DOE data has us nervous Trump/Xi cooperation won’t be enough to clear the overhang of crude oil stocks.

In the Middle East, Saudi Arabia confirmed October crude production at 10.3m bpd. The mark represented a 1.2m bpd improvement from September when Iran-lead drone strikes knocked millions of barrels of production offline. At the time of the strikes, Saudi officials were steadfast in claiming their output would return to form within weeks. The October data seems to confirm the Kingdom was extremely effective in getting back to business as usual.

On the trade front, US and Chinese officials continue to signal that Phase 1 of their trade deal is nearly complete but have avoided setting a date to sign a preliminary agreement. Markets watched Trump’s speech at the NY Economic Club closely for timing hints this week but were ultimately disappointed when the President didn’t offer the firm timeline that markets are looking for. Nevertheless, US equity markets continued to reach new record-highs suggesting baseline expectations see a deal around the corner.

Back to the fundamental side, last week’s US petroleum inventory report was highlighted (or lowlighted) by yet another massive crude oil supply build of 7.9m bbls. The stockpiling brought overall US inventories to 447m bbls representing a 3.5% y/y surplus- not exactly impressive figures for an economy growing at more than 2%. As for the cause, bloated US crude fundamentals are currently being driven by robust production as well as poor demand. On the production side, US output continued to plod along at a record-high 12.6m bpd despite the decline in the US rig count for an incredible 1.4m bpd y/y improvement. At the same time, US refiner demand has averaged 15.77m bpd over the last four weeks for a 585k bpd y/y decline. If we combine the rise in production with the fall in demand, we get a supply/demand balance decline of about 2m bpd and all of a sudden it makes sense why crude oil markets are soft despite massive efforts from OPEC to tighten the market.

It's also worth noting that physical oil traders seem unimpressed with talks of ‘Phase 1.’ This week the Brent 2H’19 spread yielded just 20-cents per month of backwardation which is a somewhat weak structure. If the largest oil merchants are waiting for firm proof of fundamental improvement before going aggressively long oil- perhaps you should too.

We continue to think that a sharp crude oil rally will be impossible until a US/China trade deal is inked. However, it’s becoming more and more clear to us that the deal would also need to stimulate economic activity and lead to an actual increase in crude demand to clear the overhang of crude supplies. A trade deal can’t clear the glut of crude by itself- we’ll need an actual improvement in global crude fundamentals for oil prices to meaningfully strengthen and break out of their current range.