Oil Price Won't Rally Until This Happens
Oil can't see a sustained price rally without a major geopolitical question being answered first.
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The term "cheap" is often associated with the price of oil, which is what entices a lot of investors to be long as they see limited downside.
However, limited downside does not mean unlimited upside. In the case of oil, it is limited on both sides it seems, making it a huge opportunity cost for investors, at least the short-term ones. "Cheap" is not a term that matters in commodities, as they can stay cheap for long periods of time. Commodities are not dictated by value, they are dictated by demand and supply balances and the need to move them from one place to another to close the pricing difference, if there is one.
If demand is endless, price can go to infinity, even, until supply incentives come back with a vengeance. But if demand is not existent, then prices can fall to the negative. We learned that during the COVID-19 pandemic, when WTI fell down to -$35 per barrel on one given day! Commodities are not like equities, there is no book value or balance sheet value, as such.
For over three years, the price of oil stayed muted in a range of $70 per barrel to $80 per barrel, brent. This was "with" OPEC+, especially Saudi Arabia, doing its very best to hold oil offline in the hopes of stabilizing the market and seeing it grind higher towards $100 per barrel, when demand would pick up. What was meant to be an adjustment for a few months ended up lasting for years, to the detriment of Saudi Arabia, which lost not only revenues with lower oil prices but also market share as non-OPEC members supplied more oil and at cheaper prices, especially U.S. shale oil.
Fast forward to this year when President Trump took office. One of his first priorities was to tackle the price of oil as he vowed to his constituents. A few months ago, Saudi Arabia surprised the market and released three-times the oil during its monthly production, especially as the price of oil was lingering around the low $70s. Most sell-side analysts had pencilled in no increase until prices got to above $90 per barrel. Perhaps this was done in good faith, in lieu of a better working relationship with the U.S., as evidenced by the recent Trump tour of the Middle East and the deals being signed between the two countries.
During his trip, Saudi Arabia ordered billions of dollars of semiconductor chips from Nvidia NVDA and Advanced Micro Devices AMD. Nvidia also announced a partnership that seeks to turn Saudi Arabia into a “global powerhouse in AI, cloud and enterprise computing, digital twins and robotics.”
The company will be working with Humain, a subsidiary of the Saudi public investment fund that was launched recently to focus on AI. Even Amazon AMZN announced that it will invest $5.3 billion in a partnership with Humain to build an AI zone in Saudi Arabia. The Trump administration's focus is to get as much dollar investment into the country as possible, as this will help offset the fiscal deficit, leading it toward a path of higher productivity.
Oil is a lot more geopolitical than most think, but it is safe to say that there is no shortage of oil these days. A lot of hope was put on Chinese demand recovering, but China is going through secular stagnation in addition to its oil demand needs having changed as it moves away from diesel into alternatives.
The fair value of oil was a lot lower for many years — it is only now catching up to its equilibrium as the valves are opened. Stale bulls keep quoting low U.S. SPR inventories, but that is no longer valid since the U.S. shale revolution changed that dynamic. The question lies not in whether oil is cheap, but whether the global economy is undergoing a recession or a soft patch.
Before prices can rally sustainably, all of that excess oil supply needs to be soaked up first.
