Why ‘Lower for Longer’ Is Dead

It’s one thing to know something in theory, another to experience it in reality. That’s certainly the case with the energy sector’s infamous boom-and-bust cycle.

If you’ve ever spent time looking at a chart showing the rise and fall of crude oil prices, the tops and bottoms probably looked stunningly obvious.

That may fool you into thinking you have the fortitude to ride the cycle through its highs and lows.

But I’ll never forget the world-weary sigh of one investor who had spent his career toiling in the energy patch. “Yeah, I know all about the boom and bust cycle,” he said with the most rueful laugh I’ve ever heard.

Markets make for cruel mistresses. Bull runs can go on far longer than what seems even remotely reasonable. And crashes won’t end until the last disgusted investor throws in the towel.

There are no prizes for attempting to time a market—and inevitably getting it wrong.

Get in too soon before the bottom and you get bloodied. Get out too soon before the peak and you miss out on a parabolic gain.  

These days, there’s so much market noise, it’s easy for just about any observer to summon the data necessary to sow doubt regardless of where things stand.

When you add computerized trading into the mix, even a small selloff can turn into a self-fulfilling rout. The resulting volatility can make recent events feel as if they happened an eternity ago.

Cash on the Barrel

Only just last week, crude oil prices reached their highest level in nearly four years.

With the oil market expected to come back into balance later this year, analysts and other market observers were starting to fret about eventual shortages.

Political turmoil in Venezuela and sanctions against Iran could remove as much as 1 million barrels per day from the market. Meanwhile, forecasters are looking ahead to possible supply disruptions when a new environmental rule for bunker fuel takes effect in 2020.

Together, these factors had some energy analysts making bold calls for triple-digit oil prices in the next couple years.

Bank of America (NYSE: BAC) predicted that oil prices could rally to $100 per barrel by next year. The well-known emerging market investor Mark Mobius echoed that call.

One of the energy sector’s most prominent hedge fund managers, Pierre Andurand, went even further, suggesting that it’s “not impossible” for oil to hit $300 per barrel in a few years. He believes that under-investment in future production could result in a supply shock.

Though these are just opinions, investors started putting their own money on the line too. Options traders began betting that global benchmark Brent crude oil would top $100 per barrel within the next 12 months.

The futures market hasn’t been quite as dramatic. However, prices for future delivery of oil over the next five years have perked up recently as well.

OPEC’s Gut Check

Not all of these wagers were predicated on OPEC maintaining its supply-cut agreement, but at least some of them were.

In 2016, the cartel of major oil producers decided to cut output by 1.2 million barrels per day in order to help bring supply and demand back into balance. Recently, however, OPEC has been significantly exceeding these cuts, in part due to Venezuela’s rapidly falling production.

Now, the cartel is worried that it may be ceding too much market share to prolific U.S. shale oil producers, who keep setting new records for output.

So late last week, key producers Saudi Arabia and Russia said OPEC would consider boosting production again, which would help replace the lost barrels from Venezuela and Iran.

Both vowed that any production increases would be gradual. The move may simply put the cartel closer to meeting the production targets of its original supply-cut agreement.

It also suggests that OPEC may see $80 per barrel as the new price ceiling for the commodity, at least until Saudi Arabia gets closer to the initial public offering (IPO) of a 5% stake in state-owned oil giant Aramco next year. OPEC’s next meeting is on June 22.

Down, But Not Out

The prospect of higher production from OPEC comes with a surprise inventory build in the U.S. The Energy Information Administration last week reported a build-up of 5.8 million barrels of crude vs. forecasts for a 2 million barrel decline. These factors were enough to send prices tumbling.

Then over the long weekend, fears that political turmoil in Italy and Spain could undermine Europe’s currency union caused markets around the world to hit the panic button. Oil fell even harder.

At one point, North American benchmark West Texas Intermediate crude oil was down nearly 10% from its peak of less than a week ago. But the bulls, perhaps feeling a bit chastened, seem to be back.

Even if OPEC decides to boost production, Saudi Arabia’s potential $100 billion Aramco offering, which would be the world’s largest IPO ever, likely looms large in its calculations. Analysts have balked at such a valuation for Aramco, but triple-digit oil prices could help remove their qualms.

Meanwhile, the macro picture still suggests that, at the very least, the former consensus that oil prices would stay lower for longer is coming undone.

Indeed, the very man who coined the phrase, BP (NYSE: BP) CEO Bob Dudley, later said he meant “lower for longer, but not forever.”

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