The Oil Pullback Could Accelerate

Market players still drugged by the lure of triple-digit prices for WTI are having to accept reality - oil is overpriced and not in short supply. The mirage of Brent bouncing to $125, promised as certain in 2013 by Goldman Sachs (GS), has been removed from the scene, by GS itself, delivering just another broken promise from the firm.

Present hopes for pushing oil prices ever upward reside on a range of "neo-fundamentals" like the general equity asset boom, US Fed and ECB rate decisions, Emerging Economy growth, and Syrian-based Middle East conflict. Oil producer plans, policies and ploys come later.

The ECB was almost obliged to cut its near-zero interest rates, which it did, but while the Federal Reserve is in a closely similar situation, it may have margin for delaying further rate cuts. This only shifts the very near-term picture for oil prices to a balancing act where there is weak manufacturing data coming out of China on one side, and predictable Western central bank easing on the other.

Whether this can blow more steam back into oil prices is not too certain. China's national data provider, including the Bureau of Statistics and purchasing managers, paint a picture of continuing taper-down in China Inc. growth. Present Chinese data is only just above the expansion-recession sill, lower than analysts' forecasts preceding the data. US output is also similar - that is similar "unexpected" weak economic numbers are the New Normal. None of this points to stronger oil demand.

The ECB is in no shape to menace an exit strategy for its own brand of "easing" or country bail-outs and bail-ins, but ECB policy impacts on European oil demand are zero. In theory, the US Fed offers more bang for the buck, but that theory is also hard to verify with realworld facts. What we can note is that nothing the Fed has done since the Lehman Bros moment in 2008 has seriously levered up US oil demand since then.

Inflation numbers in Europe are already low across the continent, and negative (deflation) in some countries. US inflation is described as "faltering" while US economic data continues signalling that the Fed's hoped-for flip upwards in inflation is missing, presumed dead. Low oil prices and this real world scenario of low or declining inflation, dovetail perfectly.

Russia And Kingdom Of Saudi Arabia
Both have already produced ritual growls at the overdue retreat from triple-digit oil prices, but through the 1990-decade both of them lived (or at least survived) with oil at $15 per barrel.

Both are also producing oil at all-time record rates or close to that, despite global oil demand growth forecasts being constantly trimmed - even by OPEC Secretariat analysts! The disconnect is almost perfect. The shale gas revolution in the US has already severely rattled the Gazprom-Putin duo, because global gas prices, often three times US domestic prices, are softening. Putin has ordered a boycott by all Russian state controlled companies, meaning Gazprom (GAZP.ME), on cooperating with European Union anti-trust investigators who are closing towards levying heavy fines against Gazprom for a decade of price-fixing and high-handed gas supply cutoffs for European consumers.

To be sure, still today, Gazprom can go on raking $15 per million BTU on some contracts - but US natural gas prices have dire problems holding on to $4 per million BTU!

Despite gas prices softening, high oil prices are still treated by the Kremlin as an acquired right - like high gas prices were - and this touching antique mentality is shared by Saudi princes and aristocrats. A recent report in 'Wall Street Journal' gave an insight to rare public disputes inside The Kingdom between oil minister al-Naimi and the high-rank princes Faisal and Turki, over long-term production targets - of 15 million barrels per day by 2020 - for the world's largest crude exporter.

Al-Naimi has to face daily reality in his oil minister role. Racking up Saudi production from its current 12.5 Mbd capacity (9 Mbd output with about 3.5 Mbd held as spare) would create more threats than promises. Turki's ideas, or notions that KSA can produce more oil and export more without hurting prices is not rational although to give Turki credit, Valdimir Putin imagines exactly the same thing.

The Kingdom and the Kremlin play their game of "plausible denial" on whether they want high oil prices, or "reasonable" prices. Saudi spare capacity is a closely watched metric and two of the strongest most-recent periods of oil price gouging—in 2003-2005 and 2007-2008—were partly enabled by, or coincided with OPEC spare production capacity, concentrated in Saudi Arabia falling to low claimed levels. The ex-post rationale, from both the Kingdom and the Kremlin, is that a price bulge was needed to rebuild capacity but at the same time, both say: "we likely won't do it again".

Same Old Music
OPEC and Russia ritually say they do not want or need high oil prices, because high prices damage demand and consumer confidence in oil. Linked to this, both believe the world cannot kick the oil habit and especially when it concerns KSA, domestic oil demand is forcast to grow so fast and so much that the Kingdom could be imagined as literally drowning -- in oil demand. Royal family members themselves take part in this sport, forecasting national demand at 5 Mbd by 2020, giving the incredible annual demand rate of 60 barrels per person. Nobody else in the world (with a tiny exception called Qatar) comes anywhere near that rate of burning oil.

World average annual demand is about 4.5 barrels per person.

Hence the Saudi race for increased oil production capacity, needing "reasonable" priced oil defined by Saudi princes the same way Putin and the Kremlin appreciate "reasonable" prices. When or if prices spike again to $150, the spike will be denied as having nothing to do with them, on the time-hallowed basis of "Take it or Leave it". In Europe however, years of bowing and scraping to the Gazprom giant have come to a full stop - the shrinking giant is now treated as a gas price gouger and price fixer - because European consumers have found other and newer suppliers, at more reasonable prices. The dollop of traditional arrogance they received in the past has also gone.

Even in Europe, gas prices are falling. It took a long time, the shale gas revolution was needed along with epic-sized offshore stranded gas discoveries, but it happened. The same is happening to oil prices for the same mix of reasons, which are now really just two. These are increasing supply and slow or declining growth of demand, sometimes outright contraction of demand - anywhere in the world except Saudi Arabia.