Australian dollar and the oil shock

DXY was own Friday night as EUR and CNY rebounded:

The Australian dollar was mixed against DMs:

And EMs:

Gold fell:

Oil fell:

Metals bounced:

Miners are in heaven for no known reason:

EM stocks pushed higher:

Junk too:

Treasuries were smashed:

Bunds too:

And Aussie bonds:

Stocks were firm:

Westpac has the wrap:

Event Wrap

US retail sales rose 0.4% in August (vs 0.2% expected), mostly reflecting strong auto sales, and July was revised from 0.7% to 0.8%. Core measures were less impressive, though, the control group up 0.3% as expected. Overall, the report indicates consumer activity remains healthy.

US consumer confidence (Michigan Univ.) increased from 89.8 to 92.0 (vs 90.8 expected).

Inflation expectations for 5-10yrs ahead slipped from 2.6% to 2.3%, although the year-ahead measure rose from 2.7% to 2.8%.
Event Outlook

China: The Aug monthly NBS data release will provide updates on fixed asset investmentindustrial production and retail sales. Global weakness has continued to hold back activity, and some challenges in the labour market are limiting upside for retail sales.

EuropeECB Chief Economist Lane speaks in London.

The news all changed over the weekend, as oil took centre stage, via ZeroHedge for another wrap:

Here is Goldman’s take:

Following the events in Saudi Arabia, well-informed market participants expect that oil prices may increase by $5-10 per barrel in the Asian session.

Higher pressure on CNY, but also negative for TRY and INR due to elevated current account deficits.

Too early to assess the exact macro impact by it is bright clear we don’t need an oil shock…

A shocking lack of additional information has been released since the initial headlines yesterday afternoon that attacks on Saudi infrastructure would halt nearly half of Saudi output.  With even Donald Trump quiet on the issue there remains more questions than answers.

A thorough summary of events and quick market backdrop from my colleague, Elise Backman, is attached.  The long and short of it being that the Saudi’s Abqaiq facility processes up to 7mbd of crude and Khurais that was also hit produces about 1.5 mbd. It’s not an overstatement to call Abqaiq and its surrounding areas the heart of Aramco’s empire. In our view, the flaring pictures from NASA satellites make it very likely that some production is down; these flares are likely not from the attacks but more from the facilities going into emergency shutdowns.  Aramco is built and setup with a lot of redundancies which is why you rarely hear of major outages – given the importance of Abqaiq we expect these redundancies (extra piping, spare stabilization units, extra tanks, etc.) to be even more prevalent at the facility.

However, this is a meaningful change for the crude market and highlights the vulnerability of Saudi infrastructure, and ongoing instability of the Middle East.  While the market needs more information in order to make a determination on the direct impact to balances our expectation is for the market to trade definitively stronger with high levels of activity from the discretionary, systematic and corporate community likely creating a raft of opportunities.

Two oil facilities in Saudi Arabia were targeted on Saturday by drone attacks, with the extent of the damage highly uncertain yet potentially significant: half of current production was halted while reports indicate that a re-start of most oil output could occur in days or weeks. The potential for a prompt resumption of production hinges on the fact that most damage occurred at a processing plant rather than a field.

This is nonetheless a historically large disruption on critical oil infrastructure and these events represent a sharp escalation in threats to global supply with risks of further attacks. These events are therefore set to support oil prices at their open on Sunday, especially given recent growth concerns and low levels of positioning. The magnitude of such a price rally is difficult to estimate in the absence of official comments on the timeline and scale of production losses. We nonetheless provide a rough first estimate of possible outcomes based on our pricing framework and the experiences of the 2018 Iranian sanctions and the 2011 Libya production losses:

  • A very short outage – a week for example – would likely drive long-dated prices higher to reflect a growing risk premium, although short of what occurred last fall given a debottlenecked Permian shale basin, a weaker growth outlook and prospects of strong non-OPEC production growth in 2020. Such a price impact could likely be of $3-5/bbl.
  • An outage at current levels of two to six weeks would, in addition to this move in long-dated prices, see a steepening of the Brent forward curve (2-mo vs. 3-year forward) of $2 to $9/bbl respectively. All in, the expected price move would be between $5 and $14/bbl, commensurate to the length of the outage (a six month outage of 1 mb/d would be similar to a six week one at current levels).
  • Should the current level of outage be announced to last for more than six weeks, we expect Brent prices to quickly rally above $75/bbl, a level at which we believe an SPR release would likely be implemented, large enough to balance such a deficit for several months and cap prices at such levels.
  • An extreme net outage of a 4 mb/d for more than three months would likely bring prices above $75/bbl to trigger both large shale supply and demand responses.

Those prices look optimistic to me. I am no oil bull but we can now expect:

  • an ongoing $5-10 permanent risk premium in the oil price;
  • this is bullish US shale and bearish Saudi in the long run;
  • there is a non-trivial risk of this getting out of hand in terms of proxy war outcomes if the US decides to pressure Iran which is China’s ally;
  • a medium term 4 mb/d outage would lift oil towards $100.

The forex implications flow from these conclusions:

  • USD bullish as shale is switched back on and there’s safe haven bid, plus the Fed is given greater pause to cut given US inflation is already stirring on tariffs;
  • EUR bearish on the reverse of the same;
  • the AUD is a mixed impact, balancing a smashed consumer versus a lift in LNG sector. Given only the first actually impacts the real economy, it will be net negative for the AUD. I don’t see it delaying the RBA given there is no inflation and it would seek relief for a beleaguered consumer;
  • gold up in the short term and perhaps down before long as the USD rallies, though up again if proxy war develops;
  • bonds belted initially but bid as it sorts itself out and the damage to global growth becomes the story, and
  • stocks negative initially on the reverse of that. The longer run will be determined by the growth damage.

I do not see proxy war as the base case given Donald Trump’s Jacksonian instincts are to avoid such entanglements but Pompeo was quick to jump on Iran and US allies, Israel and Saudi Arabia, will be chomping at the bit so it is a material risk.

Comments

  1. Shifty Politician

    So far the US has taken out or attempted to take out oil suppliers including Venezuela, Syria, Yemen, Iran, Iraq, Russia, Libya which include some of the biggest oil producers on earth – and almost no impact on oil prices (remember they were at $150 / b in the 2007 !!)

    And now half of Saudi Arabias supply gets hit – no worries.

    People seriously need to update their views on how the oil market works – 10 years ago a hit like this would have sent the world into total chaos.

    The reason ? People refuse to accept basic reality as it conflicts with their political ideology and desired, preferential views. So its just ignored.

    https://www.bloomberg.com/news/articles/2019-03-19/forget-tesla-it-s-china-s-e-buses-that-are-denting-oil-demand

      • Shifty Politician

        Half of Saudi Arabia’s oil production was wiped out – and oil fell.

        China gets its oil from Russia and Iran now. Massive new pipelines directly into China.

        It may be “material” but clearly its not having any significant impact. Again – oil prices were close to $150 and spent most of their time between $70-$100 – they now hover somewhere between $40-$60.

        Its no longer material – electrics are totally dominating. 76% of all global oil production is used in domestic transport – the fastest transition to electrics of any segment.

        This is the new paradigm and people need to get their head around it. Its called the “iPhone curve” – there is minimal take up for many years of smart phones (Sony P90 came out in 2003) then there is a sudden explosion.

        People are simply not understanding the take up of electrics in the last 2-3 years in China – its crazy.

        There are 400 electric car manufacturing companies in China – electric cars start at $10k – with electric scooters taking over much of inner city transport.

        The demand for oil will halve again over the next 3-4 years, then again. Thats the “material” aspect of this – and thats what a direct military hit on the worlds largest supplier wiping out half its production capacity having almost no impact on oil prices – actually shows us.

        The reason its not considered is because it impacts on US hegemon and “celebrates” a Chinese achievement which is entirely unacceptable to the narrative – which is a genuine shame. Analysis should be objective, not subjective.

      • Wouldn’t be surprised is Saudi’s and US did it to give them an excuse to send a few missiles into Tehran and don’t the Saudis need a higher oil price for the IPO
        Call me cynical

        • Totally agree. This Aramco IPO is becoming a thorn in their side — they can’t afford to ‘give it away’ since it has been the royal family bank account for ages. When they sell it off they need enough to sustain both the country and the royals for a long time.

          I think $1.5 trillion was the valuation they were originally aiming at but they’re going to struggle to get anywhere close IMO.

      • Makes sense. Propose a massive IPO then blow up half your own refineries before the float but blame it on your hostile neighbours because potential investors won’t factor this vulnerability into the price they will pay.
        Those crafty Saudis. Very clever.

    • I’m with you, not sure about E bus but think oil demand will fall as world slows very fast
      I’d be selling into the 60s for lower
      These blips are sometimes great opportunities to enter the opposite position

  2. If it only takes 10 drone to shut down half of Saudi’s oil supply, then the war in Yemen is the bigger strategic blunder by the Saudi monarchy. They created an enemy with massive force multiplier and nothing to lose.

    This makes a war with Iran less likely, because $200 USD a barrel means a global recession.

    • We may never know who did, but rest assured the usual suspects will be trotted out.

      I always ask “cut bono?” Who benefits? The USA benefits more than any one. Shale prices up, debt reduced, a bit of very necessary inflation and China having to find yet more US $ to buy oil, plus it hurts them as the world’s biggest importer. Did the USA do it? Did the Saudis do it themselves to muster more support for the war in Yemen and suppress a bit of domestic angst? Was it the Israelis playing false flag to wind up stress on Iran? Was it Iran, attacking the Saudis to say to the US and Saudi “don’t fcuk with us”?

      Let’s see who played big games with oil futures the week before…the old 9/11 money play

      • A good comment (very unusual) at ZH this morning
        WhatTheHellisHappening
        What we all call doom porn articles about fundamentals and history repeating should in fact be happening. I can’t speak for you, but the fact it never does almost makes me scoff at it these days..
        The real question should be.. why is what should be happening not happening? That in itself implies something or someone is playing this game much more fanatically than we are.
        After all.. power is at stake. Something you and I will never understand. Power of business and financial aspects sure. Well.. who knows. Maybe some of you do have real power. But..
        100’s of millions of human beings have died for such a simple word with such far reaching consequences.
        We better be careful. Or I, at least, will scoff at the thing that completely destroys my life because MAGA or because I’m now way too cynical for my own good..
        Hmmmm..