From the Economist's Chair: US election fog could intensify crude’s roller coaster

Author David Fyfe, Argus Chief Economist

Intra-day crude volatility has doubled since early-September, on renewed uncertainty over Opec+ intentions, recovering Libyan production, weakening oil demand amid resurgent Covid-19 and, not least, a fractious US Presidential and Senate election campaign, which may see results contested beyond election day on November 3.

Short term oil market prognoses have turned bearish for fourth quarter 2020. Oil demand projections through 1Q21 are being revised down. Renewed lockdowns and travel restrictions in many territories will last through November and beyond if infection rates are not curbed significantly. With Libyan supply recovering towards 1 mb/d, Opec+ Ministers are expected, at the very least, to forego a scheduled +2 mb/d January production increase when they meet on 1 December, although whether for three or six months remains unclear.

This week’s US election generates a further mist of uncertainty that could keep crude prices whipsawing, not just through mid-2021 but into the medium term too. At writing, eve of election polls imply a clean sweep, with Biden taking the Presidency, and the Senate passing from Republican to Democrat control. While 2016 clearly demonstrated the hazards in believing the polls, such an outcome would imply a bullish knee-jerk reaction from the market, as Biden’s plans for a rapid and substantial fiscal rescue package, plus greater Federal coordination of state Covid-19 responses, could more rapidly check the ongoing “third wave” of US Covid-19 cases.

But an immediate, post-November 3 price rebound is far from assured. Firstly, with a high proportion of votes cast being postal ballots, and with state-specific rules around vote count deadlines, definitive results could be delayed for days beyond Tuesday. And that is before considering the myriad legal challenges being concocted by both sides in swing states should results not go their way. The spectre of Florida 2000 looms large but is unlikely to deter attempts to challenge results in the tightest races.

The Supreme Court could potentially be called upon to decide. Normally, State Governors must certify election results and anoint electoral colleges by mid-December, passing the results of their votes to the Senate before Christmas. But there is little that is normal about this election, suggesting further delays cannot be discounted.

If there is indeed a Democrat sweep, combined with a December Opec+ agreement to hold output steady, this is more likely to provide a floor than an escalator for crude prices during the next couple of months. Bear in mind that until the US electoral smoke clears, Covid-19 caseloads are still accelerating worldwide and the resultant tightening of constraints on movement and commercial activity will still weigh on demand, potentially deferring further crude and products stock draws through the end of 2020, regardless of US domestic political shenanigans.

Nor does the post-inauguration calculus from January 2021 onwards become clearer either. Conventional wisdom so far in 2020 implies a Biden win would be overwhelmingly bearish crude in the short-term, due to a new President likely prioritising US re-engagement with Iran, leading to a rapid resumption of between 500 kb/d to 1 mb/d of Iranian exports. In reality, the US seems unlikely to return to the JCPOA deal as it stands, and there could be several months of negotiation to verify and dial back on renewed Iranian nuclear activity that has occurred during the Trump Presidency. Iran’s return to the crude market, when it occurs, is bearish all-things-equal, but substantial export volumes might not appear before second-half 2021 or even 2022.

Before that, the incoming US President will focus on resuscitating the domestic economy. The 33% annualised rebound seen in 3Q20 US GDP needs to be placed in context: it was a reaction to the record annualised contraction of -31% seen in 2Q20. With late-October US unemployment still around 22 million in total, and clear signs that economic recovery is now being reversed, every cent of a proposed $US2 trillion fiscal rescue package will be needed to backstop the economy in early-2021. This week’s Federal Reserve policy meeting, while unlikely to signal a policy shift of its own, could reiterate Chairman Powell’s previous calls for legislators to step up to the plate with more fiscal support measures.

Assuming a rapid, substantial US stimulus is forthcoming and successful containment of the virus (both US and globally) is achieved by early in 2021, the stage could then be set for renewed gradual strengthening in crude prices in the first half of next year. Oxford Economics suggest that a Democrat sweep potentially adds 1.2 percentage points to 2021 US GDP growth compared to the status quo of a Trump Presidency and a split Congress. Stock draws re-enter the equation in such a scenario, assuming oil demand is recovering, US shale growth stays anaemic, and Opec+ indeed foregoes January’s scheduled supply increase.

Thereafter, the outlook gets murkier once again. Of course, the possibility of an effective and widely available vaccine against Covid-19 from mid-2021 would help further underpin global economic recovery, and oil demand with it. But price gains may still be moderated by supply-side uncertainty, not least the response of Saudi Arabia and Russia to recovering Iranian and Libyan volumes.

Longer term too, a Biden victory would be a mixed bag for oil prices, the more so if augmented by Democrat control of the Senate. An additional $2 trillion allocated to green energy and infrastructure investment may be bullish the broader economy, but scarcely supportive of either US oil demand or domestic production. Ultimately, the trillions spent on rescue and stimulus packages have to be paid for, entailing a likely mid-decade combination of corporate tax increases and interest rate rises, potentially yet more headwinds for an already-consolidating upstream shale sector.

Federal lands would be off-limits for new drilling under Biden, suggesting potentially steeper decline rates for current production amounting to some 2.7 mb/d of oil and 3.5 Tcf of gas. And with Democrats likely to fast-track US re-entry to the Paris Climate

Agreement, tighter clean air and climate regulation, accelerated renewables investment and ambitious EV targets are all part of the policy agenda. These could weigh not only on conventional motor fuel demand, but also the upstream cost of capital over the longer term.

Warren Buffet once said that forecasts tell us more about forecasters than about the future. Mid-pandemic, in a recessionary, geopolitically-hyperactive US election year, we should maybe cut forecasters a little more slack. “Forecasts illuminate the uncertainty more than they do the future”, perhaps?

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