My 'no-brainer' oil bet

Abraham George Macro Musings

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Oil is clearly above $80. In all my writings so far in the last two years, I think it is safe to say that I may probably have the best track record in oil. When Biden came to power, oil was around $25 and I called it the ‘no-brainer’ trade to be long oil. I do not write much about oil regularly, writing only when it matters. Whenever it made a deep correction, I suggested oil is a great buy. Even recently when it broke above $77, I suggested it was a buy again. Will it continue to go higher? Well it can but I want to throw a word of caution here.

We have come a long way since the negative $37 per barrel low in Apr 2020. By the way when I talk about the price of oil it is always the west Texas Intermediate (WTI). That’s when futures traders were worried that they will get stuffed with oil drums showing up at their office desks.

I was in Sydney then and I remember filling gas at a petrol station. I told the young teller girl while paying for the gas “by the way you should be paying me for taking your petrol”. She rolled her eyes and made me a sort of poker face and I surely knew she did not understand what I was talking about.

In a couple of weeks when I met her again, I think she would have paid attention what happened with oil in the markets and asked me “can you please explain to me what comment you made two weeks back?” So I explained to her about the unusual market situation of the oil futures markets then. Incidentally, she was an economics student working part-time at the petrol station to support her studies. That might explain her interest.

One of the biggest hedge fund managers who made a killing in oil at that time was Carl Icahn. Nobody understands oil better than Carl Icahn. He loaded up on oil and oil companies and has been laughing all the way to the bank.

The current situation in oil has a lot of similarities to what happened to oil in 2008 and 2009. Back then there was a hotshot oil analyst by name Arjun Murti at Goldman Sachs. He had a highly advertised price target of $200 and the market was bulled up for that. During the GFC oil topped out at $142 and in no time was down to $35. Heard Goldman was a seller in its run up to $ 142. Never heard from Murti again.

Oil prices are now up 300% since they normalized to around $20 per barrel in May 2020. It may not have finished climbing yet and the rally may not be still over as well. If the gas to electric trend does happen, it should roughly take another 15 years to play out. To put it meekly, your favorite gas station will still continue to be there for much longer time and won’t change enmasse to electric pumps soon.

Remember oil accounts for around one third of energy consumption globally. That’s more than coal (27pct and gas 24 pct). It’s also more than three times as much as hydro-power, wind and solar combined (9.7 pct).

Also, a lot of people don’t realize that oil is a big ingredient in things like plastic. As much as the anti-plastic drive is underway, I am sure something plastic is right in front of you right now - may be your computer. The point is we are a long way from kicking our oil habit. It’s not going to happen overnight. Forgot to mention, things like polymers, fertilizers and even textiles (you could be even wearing a petroleum byproduct). I’m not going to go into the fact that the synthetic vanilla flavour used in your food may come from petroleum derivatives. So, like I said, it is not going to go away overnight!

At the same time, the OPEC oil cartel may be still looking for a higher oil prices. The group has decided not to boost supply even as prices have risen. And in the US the government will not take any emergency measures yet to boost supply as well. On top of that the US Department of Energy indicated last Friday that it won’t tap the country’s strategic petroleum reserve (SPR) to help alleviate supply issues. They will surely at some point if the situation gets really dire. The impact of higher oil prices is a lot bigger for many emerging markets too.

By the way the Q3 earnings will be the focus this week. The discussions on inflation will be top priority too. As usual, the banks will set the tone for earnings and it should start with JP Morgan tomorrow.

As the head of the biggest bank in US, Jamie Dimon has been very much in the press. He said consumer demand is extraordinary even in the face of the supply chain disruptions and higher prices. He says consumers are spending 20% more today than a year ago. For the banks it has already been an embarrassment of riches, as they have beaten revenue earnings every quarter coming out of the pandemic, with record profits so far.

Finally let me conclude and I want to emphasize that the economics and market behaviour and positioning can be completely diametrically opposed to each other. If we can see a market top from now to four or six months in equity markets, then oil prices can shock you on the downside too.

So, there we go. Thanks for reading Breezy Briefings. If you enjoyed this, I'd really appreciate if you could take a second and tell a friend. Honestly. It makes such a big difference.

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Abraham George is a seasoned investment manager with more than 40 years of experience in trading & investment and portfolio management spanning diverse environments like banks (HSBC, ADCB), sovereign wealth fund (ADIA), a royal family office and a hedge fund.

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