Open Square Capital 3Q18: Incentives for Higher Oil Price

Smart Money
  • Up 12.65% 3Q18 and 112.5% YTD 9/30/18 vs. 7.71% and 10.56% for S&P 500 during 3Q18 and YTD, respectively
  • In Q3, fear, uncertainty, and doubt dominated as concerns of an emerging market contagion coupled with a trade-war induced China deceleration blanketed the media
  • The argument was easy to make, slower growth means lower oil demand, and lower demand means higher inventories and lower oil prices. Simple enough but we found it inadequate
  • Now as oil prices have climbed, you may be wondering what gives us confidence that there’s more upside ahead. Incentives!
  • We highly doubt OPEC 2.0’s aspirations were to achieve admiration and appreciation. It’s never been about stability or insuring sufficient supplies, nor about low oil prices as dictated by OECD importers. This has always been about maximizing oil prices for certain countries to achieve their goals
  • Self-interest corralled us down the path to the point where we’re effectively reliant on Russia and Saudi Arabia
  • Today there’s much ballyhoo about Russia and Saudi Arabia’s spare capacity. We think this is a premature question. The question to be asked isn’t if they have enough, the real question is why would they choose to produce more at this stage?
  • We shouldn’t expect anything less because today’s game is being played by the desperate and for survival. We have a 34 year old prince in Saudi Arabia who needs to pivot his country from oil-centric economy before a demographic wave of young, unemployed and disenfranchised males schooled in an education system emphasizing Wahhabism come of age
  • In Russia, we have Putin, a leader who’s strategic calculations and actions are designed to extend his power and influence globally over the coming decades; someone who brooks so little dissent he has forcibly silenced critics domestically and abroad
  • Moving forward even Trump’s exhortations will prove less effective because you can’t tweet oil into existence, and as his increasingly fractured administration advances its conflicting agendas, it will drive prices higher
  • We believe OPEC 2.0 will agree to raise 2019 production in the upcoming December OPEC meeting, softening the self-imposed cap agreed to in November 2016 and modified in May 2018
  • Lifting the cap effectively allows Saudi and Russia to take market share from Iran and Venezuela
  • OPEC 2.0 can’t openly call for much higher oil prices without inviting backlash, but delaying production increases in a tight market sends a message loud and clear
  • Shortly after mid-term elections, Trump administration will shift its focus to campaigning for reelection in November 2020. As the prospects for Republicans losing control of the White House increase, Russia will hedge and solidify its global standing in the coming year because any new administration could be less accommodating
  • Saudi will need to secure funding for its Vision 2030 program after delaying the IPO for Saudi Aramco. Without the cash infusion from an immediate partial sale, ongoing cash flow generated from higher oil price become even more important
  • We are short on energy and those who have it will begin to wield it as a source of power. The US and other oil net importers have been under the impression that they’ve been guiding energy policy, but that stance only had a semblance of believability when global inventories were filled and energy was cheap

“What’s coming around the corner for energy and energy prices will soon disrupt and then dictate the day’s conversation. What’s neglected will command attention and what’s forsaken will be coveted. The world has failed to invest in long-lead oil development projects and the repercussions of that collective failure is now playing out.”

Open Square Capital 3Q18, October 2, 2018

Image Source: Open Square Capital