OIL Going to $208 Mar 2020 10:52
According to preliminary estimates, with Brent trading at $45, a flood of Saudi supply as demand is in freefall, could send oil into the $20s if not teens, in a shock move lower as speculators puke on long positions in what Goldman calls periodically a "negative convexity" event.
Oil traders are looking to historical charts for an indication of how low prices could go. One potential target is $27.10 a barrel, reached in 2016 during the last price war. But some believe the market could go even lower.
What is the logic behind the Saudi decision?
According to one take, the shock-and-awe Saudi strategy could be an attempt to impose maximum pain in the quickest possible way to both Russia and other producers, most notably shale, in an effort to bring them back to the negotiating table, and then quickly reverse the production surge and start cutting output if a deal is achieved.
While that's certainly possible, it has already been tried once - back in 2014/2015 - and the result was humiliation for Riyadh as not only shale came out stronger, but Russia had no problems absorbing the lower prices. Instead, the most likely outcome is that Russia will be able to withstand a shock price far longer than Saudi Arabia, which has budgeted for a Brent price of $58/b for 2020 (which would lead to a 6.4% budget deficit). A realized price which is roughly half that - should the Saudi strategy work out as planned - would lead to social unrest and government turmoil in Saudi Arabia, and may explain why earlier today Saudi crown prince MbS launched another crackdown on dozens of royals and army officers following the arrest of powerful princes, who may compete for the throne once the public mood in Saudi Arabia turns nasty in the coming weeks.
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Incidentally, those wondering what is the worst case scenario for oil prices, consider that Brent traded at an all time low of $9.55 a barrel in December 1998, during one of the rare price wars that Saudi Arabia has launched over the last 40 years... similar to just now.
Could the price drop even lower now? Yes: back then there was no coronavirus pandemic destroying global oil demand.
One final point: with 10Y Breakevens driven almost entirely by the price of oil...
... once Brent craters on Monday to the mid-$30s or lower, the accompanying implosion in 10Y yields could make the record plunge in yields seen on Friday a dress rehearsal for what could be the biggest VaR shock of all time. And since QE will only send yields even lower, perhaps it's time for the Fed to add oil futures to stocks among the expanded securities it plans on purchasing as part of QE-5 to avert the next deflationary crisis which may have just started.
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