Risk vs uncertainty

Published at 14:41 25 Oct 2019 by

If there is one prevailing theme for investors at the moment, it is a lack of confidence. Investors are struggling to find belief, not because there are a lot of risks. After all, risks can be managed and even hedged. This lack of belief stems from uncertainty. Uncertainty introduces the unknown and the unquantifiable, especially at a time when policy seemingly changes hourly via Twitter. And there is a lot that remains uncertain: Brexit, trade wars, Iran, Venezuela, shale, energy transitions, IMO and central bank policy, not to mention whatever else Donald Trump may have in store. This uncertainty is why the correlation between flat price and physical market strength has broken down and why no one has any belief in sustained upside to oil.

The flip side is that any semblance of certainty or even short-term visibility will allow investors to start making some decisions. This is why we believe there is, in the near term, a case to be made for a limited ‘melt up’ in risk assets and, given the fundamental strength in oil markets, crude should follow.

The Brexit deadline looks set to be delayed by up to another three months, during which time there is likely to be a general election in the UK. This ostensibly kicks any risk of a no-deal Brexit into 2020. The US and China continue to work towards a ceasefire which will stop the tariff escalation for a period of time (see Macro digest: Evolving narratives, 18 October 2019). Meanwhile, the Fed is in easing mode. Though the Fed continues to insist that its recent overnight repurchase agreement operation (repo) and 14-day repo operations are nothing more than financial plumbing, the reality is that these actions are aimed at flooding the market with liquidity to make sure it does not see a repeat of the repo spike of mid-September.

The major headwind is, of course, earnings. But if there was continued stabilisation in Chinese macroeconomic data then sentiment should recover, as actual oil demand data are not so bad. We still think the market remains relatively short and therefore believe there is a case for a rally into year-end, especially if crude inventories continue to draw counter-seasonally. Of course, this will primarily hinge on the ‘time-out’ expected to be called between the US and China in November. A further setback in US-China talks would bring back a vortex of negativity to market sentiment.

Impeachment uncertainty
Evidence that President Trump has committed impeachable offenses is piling up, especially as it relates to Ukraine. It is very clear that the House of Representatives, with its Democratic majority, is likely to impeach Trump in the coming months. But the question remains whether or not the Senate would actually vote to remove the President. As we have previously noted, it would require at least 20 Republican senators to vote in support of removal. This is a number that, at least for now, seems far out of reach. The Republicans will argue that much of what Trump has done may be unseemly, even ill-advised, but is not sufficient grounds for removal from office. However, there is increasing angst among some Republicans who are uncomfortable with where this is going.

Notably, the Republican strategy to fight impeachment is not focused on the substance of the allegations. While most people would default to the ‘it wasn’t me’ strategy, this president of course is instead going with the ‘yeah I did it, so what’ strategy. Republicans are not denying the allegations, especially because Trump himself is admitting what he did. Instead, the focus seems to be on trying to cast the impeachment proceedings as a witch hunt—our apologies to witches everywhere—and as a purely partisan effort on the part of Democrats. Republicans will argue that Democrats cannot beat Trump at the polls and are therefore trying to remove him by extrajudicial means.

Steve Bannon, Trump’s 2016 campaign strategist, is now leading the Republican anti-impeachment strategy. His goal is to try to make the process as partisan as possible. The Republicans understand that Trump will be impeached by the House. But the goal will be to make the vote strictly up and down along party lines, meaning they want zero Republican votes in the House in favour of impeachment. There is now a ‘full-court press’ by Republican strategists to keep all their members in line and especially to make sure retiring GOP members do not vote for impeachment on their way out the door.

It is in this context that Republican members of Congress stormed a closed-door session with cameras, barging into a room set up to provide Congress, a co-equal branch of the US government, with a place to securely handle highly classified information. It was here members of three House committees were preparing to hear testimony from Laura Cooper, a deputy assistant secretary of defence.Republicans contend that this process is against the rules. In reality, the House rules being used by Chairman Adam Schiff have been in place since 2015, when they were introduced by John Boehner when the Republicans were in the majority.This was a publicity stunt aimed at delegitimising the impeachment investigation that Trump and his defenders have portrayed as a partisan inquisition. Chaos ensued as these Republican members of Congress disrupted the proceedings, forcing the Sergeant at Arms to intervene to restore order. All of this theatre was an effort to discredit the impeachment process.

Except for an initial open hearing, Democrats on the House Intelligence Committee have so far conducted their impeachment investigation entirely behind closed doors. They have yet to release transcripts of their depositions, either to the public or to other lawmakers. The decision to do so was taken to prevent witnesses from coordinating their stories. It is quite remarkable that Republicans are taking steps outside of the law to defend a president who claims he is above the law. The saga brings to mind an old Carl Sandburg quote: ‘If the facts are against you, argue the law. If the law is against you, argue the facts. If the law and the facts are against you, pound the table and yell like hell.’

Election uncertainty
Meanwhile, the market is also looking ahead to next year’s presidential election. In the last month, as Democratic candidate Elizabeth Warren has closed the gap on Joe Biden, the market has started to modestly price in the possibility of ‘President Warren’. But, while the market continues to fret about a possible Warren victory, we still note that this Democratic primary remains wide open. If anything, the frontrunner is ‘undecided’ as a large majority of the Democrat base has yet to decide who they will vote for. Moreover, despite the scandals surrounding Joe Biden, his numbers have remained sticky, at around 30% in most polls and he has demonstrated some staying power. He is still leading Warren, though she has closed the gap.

There are also limitations to what Warren or any president could do with regards to sweeping changes to energy policy. For example, there is no realistic scenario where a president could impose a blanket fracking ban. While the government might be able to ban fracking on federal land (a multi-year regulatory process that will take a very long time to hammer out and would then likely face lengthy litigation proceedings), the executive would not be able to impose a ban on private land. It is extremely premature to judge Warren as the Democratic frontrunner, and Trump supporters certainly have an incentive to promote him as the only thing standing between us and a socialist bogeywoman.

It is true that Warren remains to the far left of the core of the Democratic party base and it remains unclear whether a leftist platform would be enough to carry the party. The key question remains whether, should Biden slip, someone else will emerge to occupy the centre. The main candidates remain Amy Klobuchar, Pete Buttigieg or Kamala Harris.

For the time being, almost everyone is discounting the possibility that Trump will be removed from office by impeachment. The consensus is that that the Republican-controlled Senate would never remove him from office, mostly due to fears that the Trump backers would unleash the mob on them. For Republicans in the Senate, this becomes a simple question of costs and benefits and whether their chances of keeping their majority in the Senate go up or down by shielding Trump. If evidence emerged that was so damning that it forced Republicans to abandon Trump and removed him from office before the election, it would put the Republican party in an interesting predicament. Ostensibly, Vice President Mike Pence would become President and would immediately become the GOP frontrunner in the 2020 election. Pence is a bit of a bridge between establishment Republicans and the populist wing of the party. While he is not a Trump populist, he is close to the evangelical and rural base, but retains ties to the traditional GOP establishment on economics and foreign policy. Moreover, many traditional Republicans would love an alternative to Trump, a path to a considered policy process and a return to functional, if ideological, decision-making. Finally, Pence is a serious China hawk.

On paper, this may seem like a no-brainer for the GOP rank and file and especially the evangelical and fiscally conservative base. However, the reality is that the core of the GOP remains terrified of the ‘stable genius’ and his hold on the populist mob that Trump has somehow harnessed. And with Bannon threatening the rest of the party to stay in line ‘or else’, it may be a bridge too far for the Republicans to go down this path. Ultimately this is a decision for Senate majority leader Mitch McConnel.

That said, a Pence vs Warren election would present an interesting choice between extremes for American voters. It would be almost an impossible choice for independents and moderates. An ultraconservative, evangelical right-wing candidate (even if he is closer to the centre fiscally, he is far to the right socially) versus a candidate who is very left-wing both socially and economically. America used to be described as a country having one political party but with two factions: one right of centre and the other left of centre. But for the time being, the centre is in hiding and seemingly nowhere to be found. 

The Outlook
Brent: As we noted late last week, freight has finally started to ease, mostly due to a combination of shippers cancelling cargoes and refiners drawing down domestic stocks. Brent spreads have also seemingly found a floor with freight coming off. Meanwhile, European refiners remain under heavy maintenance. Globally, refinery outages have been tracking much higher than normal this year and offline CDU capacity returning between Q3 19–Q4 19 amounts to a whopping 6 mb/d. Between now and Q1 20, we expect to see a strong pull in global crude as refiners come out of turnarounds. The Brent curve has again started firming, especially further along the curve, with the Dec-20-Dec-21 spread rallying by a dollar in the last month or so.

Fig 1: Freight vs prompt Brent spread Fig 2: Brent Dec-20 vs Dec-21 spread, $/b
Source: Argus Media Group, Energy Aspects Source: Bloomberg, Energy Aspects

: A surprise draw in US crude inventories helped shore up sentiment as crude experienced a rare rally in prices mid-week. US crude stocks fell counter-seasonally last week, with total petroleum stocks drawing by 9 mb. PADD 3 led the crude draws (-3.7 mb) even with a 1 mb SPR release. A jump in refinery runs (+0.31 mb/d w/w) and a collapse in crude imports to below 1.2 mb/d (the lowest on record) drove the crude draws, further supported by exports at a monstrous 3.7 mb/d. With runs recovering, we expect crude draws to continue, especially as Middle Eastern producers continue to curtail exports to the US. Also notable was the large distillates draw despite the jump in runs. Distillate inventories are now at the lowest level for this time of year since 2014. The closure of the PES refinery means that imports will have to pick up to the USEC. But the price incentive to do so is not there yet.

Fig 3: Ytd US inventory changes, mb Fig 4: US distillate inventory, mb
Source: EIA, Energy Aspects Source: EIA, Energy Aspects

Yasser Elguindi, Market Strategist
+1 646 760 8100 (direct)

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