Crude Oil Market Is it a Bubble Yet?

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Over the past two months, oil prices have risen sharply along with most other financial assets. This rising tide appears to be driven principally by the narrative that the COVID-19 pandemic will subside midyear, and the global economy will rebound sharply. The recent dramatic runup in prices inevitably leads to the simple but important question – have prices risen too far too fast?

Since December, crude oil prices have increased approximately 30 percent, with Brent and WTI currently trading in excess of $61 and $58, respectively. This is the highest level since January 2020 – before the pandemic. The durability of the recent sharp increase in prices rests principally on two pillars. The first is the expectation that the vaccine rollout will gain momentum and the pandemic will recede in the second half of the year, and the global economy will rebound sharply.  The second is OPEC+ (specifically Saudi Arabia) will continue its extreme suppression of oil production until the second half of the year when demand is expected to expand as the pandemic recedes.

It is indisputable that both of these propositions carry a great deal of risk. In short, much can go wrong between now and the end of the pandemic. Aside from a small group of countries, the global vaccine rollout has been much slower than initially anticipated. At present, there is little evidence that this situation will materially improve in the near term. Moreover, as significant portions of the global population remain unvaccinated, the number of mutations is expanding and threatening the overall efficacy of the currently available vaccines. Finally, the herculean efforts undertaken by Saudi Arabia to control global supply and balance the market have supported prices. It will also presumably result in increased production from its rivals - namely, Russia and the U.S.  As a consequence, our view is Saudi Arabia will be unable to sustain its current depressed level of production past the close of the first quarter.

In light of the foregoing, it is our view that the current prices have significantly overshot market fundamentals and most likely will undergo a correction in the coming weeks. The recent momentum supporting crude prices in all likelihood is the same force push up equity and other asset prices – the gigantic wave of central bank liquidity. Market participants will have a clear view of the underlying fundamentals, which, as previously stated, will depend heavily upon the vaccine rollout and the state of the pandemic in the early part of the second quarter – i.e., late April – early May.

It is difficult to see crude prices continue their current steep upward trajectory. We are, however, living in unprecedented times.  So, the irrational (day-trading) exuberance lifting financial markets and asset prices could continue in the near term. However, like all prior speculative bubbles, this one too will burst, and crude prices fall back to more defensible levels.

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Richard Soultanian