Saudi Arabia and Russia forged a historic agreement signed by 30 countries to cut oil output by 1.8 million barrels a day at the November 2016 Opec ministerial meeting in Vienna. The output deal boosted the price of Brent crude to $56 on the eve of the May 25 Opec meeting, where Saudi Arabia persuaded the world's top producers to extend the pact but did not commit to any deeper cuts. This led to speculative panic selling in the oil market and a 20 per cent decline in Brent crude to $46 six weeks after the Opec last met in Vienna. The Saudi-Russian pact failed because US shale oil output rose by 900,000 barrels since November 2016, Libya and Nigeria (exempt from the Opec output cuts) sold more than a million barrels a day of extra crude in the spot market and global inventories rose to record lows.

Despite a six per cent depreciation in the US Dollar Index, the second quarter of 2017 witnessed a bear market in black gold. Even the Qatar crisis or terrorists atrocities in Iran, Iraq and other areas did not result in any geopolitical risk premium in Brent crude.

In retrospect, the Opec's output cut was not big enough to "shock and awe" the oil bears, especially since Russia pledged to cut output by a mere 300,000 barrels. The Opec underestimated the technology driven falls in break-even costs and access Wall Street bank/high-yield loan finance that enabled US shale oil drillers to add almost a billion barrels a day in output in response to the higher prices engineered by the Opec. Saudi Arabia and its GCC allies Kuwait and Abu Dhabi, whose compliance on the November quotas was a stellar 90 per cent, lost both market share and revenues on an epic scale. The kingdom was unable to play the role of a swing producer, the Opec's central bank of oil, in a global market transformed by the limitless shale oil reservoirs of West Texas, North Dakota and Oklahoma. The Opec's decision to exempt Nigeria and Libya from the output cut only added to the global glut building up in the Rotterdam, Oslo and Singapore spot markets.

In any case, as the North American land drilling rig count doubled, US shale output took advantage of the rise in Brent after November 2017. Three years ago, in July 2014, Brent crude traded at $110 a barrel, on the eve of an epic crash that saw the price of the world's preeminent light sweet crude benchmark plunge to $28 a barrel by February 2016. Iran, Algeria and Iraq also gamed the Opec deal by ramping up production during the two months between the negotiation of the Saudi-brokered pact and the year-end deadline for output cuts. This diluted the ultimate impact of the Opec output cuts and led to a short term surge in global inventories that led to panic selling in the New York and London crude oil futures market. Net long positions in the West Texas Intermediate futures contracts were slashed, the reason it fell as low as $42 in late June.

Saudi Arabia, the rest of the Opec and Russia are engaged in a global game of chicken with the 3,000-odd US shale oil drillers, who cannot collude on prices or output as it violates American law and whose bank loans make it imperative to maximise output even if market prices fall below the marginal cost per extra barrel. The irony is that the first synchronised global economic recovery since 2009 will lead to a rise in petroleum product/distillate demand and an increasing tightness in the global oil demand and supply balance this autumn. A decline in global oil inventories has now begun. My take? The world is tantalisingly near a short-term bottom in crude oil prices. This is the reason I accumulate Total at ?42, Chevron at 102, Oxy at 58. If Chinese petroleum demand growth continues to grow at its current rate, the decline in inventories tells me Brent crude could well rise to $54-$56 sometime in November. The time to be an oil bear is over. It is time to morph into an admittedly nervous oil bull.

Global oil demand will rise to 97.5 million barrels a day in 2018, a historic high, thanks to demand growth in India, China and Asia's industrialising "tiger economies". As long as Saudi Arabia, Russia, Kuwait and the UAE maintain output cut discipline, the decline in oil inventories will only accelerate in the next four months. This means a cyclical bottom in Brent crude.

The writer is a global equities strategist and fund manager. He can be contacted at mateinkhalid09@gmail.com.

Source: Khaleej Times