Increasing geopolitical tensions and concerns about production levels have been fueling volatility in the energy markets recently. Andriy Yastreb, Vice President for Portfolio Research at TD Asset Management, speaks with MoneyTalk’s Greg Bonnell about oil, OPEC+, and the implications for energy prices.
Print Transcript
It has been a volatile trade in the oil market. Investors, of course, considering warnings from Saudi Arabia about oil prices falling if OPEC can't maintain discipline. At the same time, you have a conflict in the Middle East that also threatens production. Joining us now to discuss is Andriy Yastreb, VP for Portfolio Research at TD Asset Management. Andre, great to have you back on the show. Thank you for having me. A very interesting time in the commodity space, energy in particular. Let's start with the Saudis. They seemed for a while there, OPEC wanting to support price. But Saudi Arabia seems to be losing patience with some of its OPEC partners. What's going on here? Well, as you mentioned, there's a lot of news flow in the industry right now. And part of the job of being an analyst covering the commodity sector is trying to disentangle what's notable and what's signal and what is actually noise. So I would actually pay more attention to what the Saudi minister is saying. Basically what he did-- he went to the media and he said that we could see oil at $50 and sometime soon if other OPEC members do not come back to the discipline and do not honor their commitments in production cuts. What's interesting about that is that he's not telling this to you and me through the media. He's telling it to other OPEC members through the media, which tells you that most likely that he already had multiple conversations about that over the phone or behind closed doors and the message wasn't well received. So the risk there is that maybe this is the final warning before something actually happens. And I have a chart here that looks at Saudi oil production and oil prices over the last 10 years. And what's interesting here is that Saudis cut oil production by a million barrels last year, in the summer of last year-- have been supporting market by doing that for over 12 months and oil prices have been down. And I think another interesting part, when I put this chart together and I looked at it, is that when oil prices are high-- and it's not always the case, but typically the case-- when oil prices are high or moving higher, Saudi's production is also high. Usually it tells you that when market is tight, that's when oil prices do well, and that's not the environment we have today. So stepping back, let's kind of see what happened in OPEC over the last 12, 18 months. So starting with summer of last year-- as I mentioned, OPEC had a meeting in June. They didn't agree on cuts that were big enough to stimulate the market, and Saudis decided to act unilaterally and had a voluntary one million barrels per day cut that we still have in place. That stimulated the market for about three or four months and didn't work that well after that. Then in December of that year we had another OPEC meeting that was supposed to be very quiet, that we just roll over existing cuts and nothing was expected to happen. Instead, it had a lot of drama around the meeting itself and Angola exited OPEC. It was pretty much dismissed by the market at that time. Then in June of this year, at the latest ministerial meeting, we had a press release, which basically rolled out a plan, a detailed table how OPEC was planning to bring back two million barrels of production over the period-- the end of 2025 by month and by country, how much production would change. It also had a footnote where the benchmark production for UAE was revised up by 350,000 barrels per day. So, for me, what all this tells me is that over the last two years or so, we've seen more and more tension building within OPEC in reaction to growth in production outside of OPEC. If you look at 2025 balances and estimates, it looks like it's going to be oversupplied market anyway, even before any barrels come in incrementally from OPEC. So the bottom line here is that there are cracks in OPEC. We'll have to wait and see how it plays out. But as investors, we have to put higher probability that possible $50 oil. Because if Saudis really want to do that, they have ability to do that. Yeah. They turn on the spigots and put the price there. In the meantime, of course, on a day by day basis we're trying to figure out what's happening in the Middle East and where it might head. It does have crude prices in the here and now higher. How should we be thinking about that? So this spike in oil prices that we're seeing this week, it's all driven by geopolitics and obviously by Israel. And I think this morning I saw headlines about Biden talking about the possibility of Israelis striking oil and gas facilities in Iran. It's interesting, because if you look at history and over the last 20 years or so, every time you had geopolitical-driven risks like this that's spiked oil, usually it didn't last very long and the disruptions were very small. I think the biggest example that you can make of that is in 2019 there was a period when Iranian drones delivered a strike on Saudi facilities and on the largest oil field in the world, large facilities, multiple strikes, multiple drones, and it was very clear that Iran did it unilaterally. So the immediate impact was that people were wondering, is this going to be a war between Saudis and Iran? And then for oil specifically, people were wondering, are we going to have one or two or three million barrels taken out of the market and for how long, how many weeks or months that will happen? And then if you look at the impact on oil prices, it dissipated within a few days and the facilities were back online within a couple of weeks. So it was interesting that actually it was a big event. It was actual impact and strike on facilities, but it was recovered very quickly. And I think the other thing to keep in mind is that everybody in this environment in the Middle East is interested in keeping oil flowing. So it's not only Iran and Saudis that want oil to continue to flow. It's also their biggest customers. And their biggest customers are China and India and Europe and the US. And I'm sure right now there is all the ambassadors from all those countries are talking to Israelis and trying to cool down hot heads in probably both countries. And then another example, more recent in geopolitical tensions-- I have another chart here that shows gas flows through Ukraine. So we've seen war in Ukraine for two and 1/2 years already. And I think a lot of people in general don't really know that Russian gas continues to flow through Ukraine, because there were long-term contracts that were signed to export Russian gas into Europe using Ukrainian pipelines, and Europe really needs gas. So despite this war going for two and 1/2 years, Russian gas keeps flowing through Ukraine. And on top of that, in August of this year, Ukraine launched a limited invasion in Kursk region of Russia. And that's where the metering station on this pipeline is. So the actual fighting was taking place pretty close to the pipeline and the metering station, but gas continued to flow. So my takeaway here is that geopolitical risks always get a lot of attention. We see a lot of headlines. This time might be different. We never know. But judging by history and what we've seen so far, usually it fades pretty quickly as well. And the key here seems to be, obviously the risk raises the risk premium on whether it's natural gas, whether it's crude oil. But ultimately, are barrels being taken off the market? And at this point, barrels are not being taken off the market. Well, if you look at demand, demand has been weak, and it has been revised down. A lot of that was driven by China, by the way. So what expectations people had at the beginning of the year for Chinese demand came down quite significantly. And on that point, even though we have a lot of excitement about stimulus, lower rates and whatnot, what's interesting here is that if you look at PMIs, manufacturing PMIs in particular that. Usually drive demand for oil and demand for commodities, they're very weak. They're under 50 in Germany, in the US, in Japan, in China. Right. So all major manufacturing regions of the world have PMIs that are still weak here. And we'll have to wait and see until that stimulus actually goes through the system and boosts demand.
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