I mention it, not to brag, but because we are in basically the same situation this morning. The market is lower after OPEC+ did finally reach an agreement over the weekend, but I have seen a lot of opinion pieces saying that we will bounce back quickly and that this is an opportunity. This time, I am a bit more sympathetic to the talking heads' bull case, but I am not about to rush to judgement.
The argument for a bounce back and a move to new highs is much more convincing now that an agreement has been reached. That removes the possibility of a complete breakdown in OPEC+ and a free for all, race to the bottom scramble to increase output while prices are still high, a scenario that could have come about had the U.A.E. and others continued to disrupt and argue, and had the whole agreement fallen apart as a result. The conspicuous display of unity that came with the announcement of this deal, however, made it clear that that outcome was the number one thing to be avoided, even if it meant restoring production a bit faster than some had hoped.
So as long as private sector output, particularly in the U.S., remains muted, and as long as demand continues to increase, a fairly rapid bounce back is on the cards. There are, however, reasons to not count on that bounce quite yet.
The first of those is technical. As you can see from the chart above, this morning's drop in CL takes us below the 50-day moving average (MA), marked by the blue line. This isn't the first time that has happened during this rally, but the last two times have seen an immediate bounce back above the MA. If we don't see that tomorrow and get two consecutive closes below the line, the technical argument for a sustained drop will be strong.
Even so, as most of you are probably aware, I don't put too much stock in chart patterns or technical analysis if there is a fundamental shift that is driving a move, which could be the case here. The delta variant of covid-19 has led to a resurgence of cases, particularly in areas with low vaccination rates, and there is a worry that that will derail the recovery completely.
However, for that to have an impact on growth and on oil demand it would have to prompt government restrictions. Anyone who saw the massive, unmasked mass of people in Milwaukee's "deer district" celebrating the Bucks' win in game 5 of the NBA finals or the crowds at the British Open Golf over the weekend (held in a place that has been hit hard by the delta variant and other Covid mutations) knows that mass restraint isn't about to happen anywhere. We have had a taste of a return to normal and aren't about to go back to restrictions voluntarily.
Those scenes also show why an enforced lockdown isn't going to happen, either. Politicians may sometimes not be the smartest knives in the block, but they will still realize that even a mask mandate, let alone a stay-at-home order, would be unenforceable as things stand. Passing unpopular, unenforceable laws and regulations serves no purpose beyond reducing your own popularity, and that is something that political types seek to avoid at all costs.
Another lockdown, therefore, is just about out of the question, so I'm not sure what the bears are worried about from an economic perspective. The unvaccinated don't seem to care if they contract the disease, and there seems to be an often-unspoken sense among the vaccinated that as long as rising infection rates don't overwhelm healthcare facilities there is an element of social Darwinism to this that will take care of itself. Those not smart enough to get protected will be removed from the gene pool and the rest of us can just carry on. Understand that I am not saying that that is right or justified, nor that refusing a vaccine is a good idea, just that both attitudes exist, and that as long as they do, the delta variant won't slow growth to any significant degree.
Without a lockdown slowing things down, what we have is oil demand that continues to increase faster than supply, even without a full return to international travel. The weekend's agreement may bring supply and demand a little more into balance over the next year or so but, without a major economic shock, the drawdown of what were bloated global crude inventories will continue or, at best, reach balance. As a result, the market looks set to stay in its current, tight state.
With a collapse of OPEC+ now off the table, a bounce back at some point soon looks the most likely outcome, and when it comes it will be strong. The events of early 2020 taught us that and memories of getting left out on that remarkable run up will still be fresh. However, what came before that bounce also taught us that no matter how logical the argument for a recovery, fear can drive market to completely illogical lows.
So, while the evidence indicates that this drop is a chance to pick up some oil-related stocks at a discount, I am holding off for now. If crude stays below the 50 MA for a couple of days, then I will hold off even longer, because the technical pressure at that point could well send us significantly lower. If, on the other hand, recent history repeats and we bounce back above the level quickly, I will be buying E&P stocks such as FANG, EOG and APA, as well as a few international names, in anticipation of a rapid recovery.
Cheers,
M
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