Cautiously Optimistic Is Still The Name Of The Game
I want to be a raging bull. I really do. The oil market deficit in 2023 looks all but certain. China will reopen, eventually, and when it does, oil demand will jump by ~2 million b/d. US oil demand is recovering and showing signs of strength into winter. OPEC+ is cutting. Russia's oil embargo is coming.
All of these things suggest our energy stocks should do well. Oil prices should go higher. But why am I not pounding the table right now? Why am I still being cautiously optimistic?
Because when it comes to investing, risk management is far more important than how much money you will eventually make. There's an important balancing act we have to follow. Yes, I am a raging bull, but in the near term, there is a lot of turbulence. It's like sitting on a plane knowing that it likely won't crash. But that doesn't mean you don't put on a seatbelt because you know it won't.
The turbulence I think we are finally witnessing unfolding in front of us is the crypto market entering the final phase of the bubble collapse. This too will have a dramatic impact on the rest of the tech sector and market liquidity in general. Combining this with China's unlikely return to the oil market this year means financial assets will be asymmetrically skewed to the downside.
Remember that liquidity is the only thing that matters in markets. Whether you are right or not about fundamentals, in the long run, is irrelevant to illiquidity issues in the short run. If there's a widespread margin call, then anything goes, and anything that's sellable will be sold.
This will, unfortunately, apply to the energy markets as well. Oil, as a result, will have to demonstrate to market participants that the physical market is strong enough to withstand the financial onslaught. The recent weakness in the broader market combined with the possibility of more COVID-related lockdowns in China has sent oil prices spiraling lower.
One of the key signals for readers to keep a close eye on will be the Brent timespread. Interestingly enough, despite the financial onslaught today, the Brent 1-2 timespread was up.
This is a great signal, in our view, because it suggests to me that this was more of a financial liquidation versus something fundamentally wrong with oil.
But similarly, the lack of a China reopening supplemented by the possibility of more lockdowns has also sent energy stocks spiraling lower. This happened irrespective of the fact that we know energy companies are still minting money around these prices.
Again, financial markets do not care about fundamentals in the near term, especially when there are margin calls involved.