A 10% oil drop is a great opportunity to buy it cheaper

Last week, oil reached its maximum since spring 2019 at around $66 (WTI brand). Now the asset is trading at the bottom of $58. A fair question arises that this happened in a few days, that the price literally fell by 10%, and also what to do with oil - to sell or buy it?

Let's start with the reasons for the increase in the maximum values for the last year. This, of course, is the assassination of Soleimani and a sharp escalation in relations between the United States and Iran, which manifested itself in the form of shelling of the US military base by Iran. The increase in tension in the Middle East has always historically been a reason for rising oil prices since the region is key to the oil market as a whole.

As for the specific case of Iran, there is a threat on its part to block the Strait of Hormuz, which is critical in transporting oil from the Middle East to China and other regions (about 25% of world oil passes through this strait). So the sharp increase in oil quotes is quite understandable and somewhat logical.

Speaking about an almost 10% oil drop prices in the second half of last week, we note that the main reason is Trump's peace-loving speech following an Iran attack on US military bases. President of the US has decided not to go for further escalation of the conflict. Accordingly, the markets believe that all will be well, and began to record profits, including oil.

In our opinion, it’s too early to relax. The conflict is far from over. Massive civil actions began in Iran in connection with the downing of a passenger Boeing by Iranian air defense and the lie about this by the official authorities. The protests are accompanied by human casualties, which in theory can provoke chaos in the country with uncertain consequences.

And the general conjuncture of the oil market is far from unambiguous and does not justify so much a sharp decline in oil quotes. An argument in favor of buying oil at current prices is the continued decline in the number of active oil installations in the United States. According to Baker Hughes, over the past week, it has decreased by 11 to 659 pcs. Thus, the number of active oil rigs has reached a new low since March 2017. According to the results of last year, the number of active oil installations decreased by 24.3%, falling from 855 on December 28, 2018, to 677 on December 27, 2019.

Why is this so important? The fact is that the offshore revolution in the United States has become the main reason for the decline in oil prices in recent years, as a result of which the United States dramatically increased oil production and became a net exporter of oil. Currently, the United States produces nearly 13 million barrels of oil per day. So the main troublemaker in the oil market is starting to lose ground. This means that in the near future the growth in oil demand will not be accompanied by the outstripping supply growth rates. In turn, this creates the prerequisites for the formation of a deficit in the market. And the deficit is a rise in prices and not at all their decline.

It is extremely important not to forget about another event, which, in fact, laid the foundation for the growth of oil prices at the end of 2019. We are talking about a new OPEC+ agreement, under which the volume of voluntary reduction in oil production by the participating countries will reach 2.1 million BPD. Recall that the previous version of the contract provided for a reduction of 1.2 million BPD. That is, the largest oil producers artificially remove very significant volumes of oil from the market with constant demand. This is the strongest bull factor.

In total, the current conditions that have developed in the oil market, ranging from the ratio of supply and demand, ending with geopolitical instability, are determined to be on the side of oil purchases. This means that the current decline in asset quotes by almost 10% is an excellent opportunity for purchases.

In conclusion, we will cite one fact that shows that current oil prices are very cheap. Last week, the Australian company Santos sold the Pyrenees, shipped in early March, at a price above $96 per barrel. Yes, this is a rather specific type of oil, the so-called heavy “sweet” oil (with a low content of sulfur compounds), but the example, in our opinion, is quite indicative in terms of the potential for rising oil prices.