Oil To Break 2020 Highs

• Re-opening of economies and less use of public transport should see energy demand pick up
• OPEC supply cuts and global producers shutting down high cost drilling should see supply fall
• We position for oil price increases through deep out-of-the-money calls which takes advantage of recent dynamics in options markets

Background:

• Global economy begins to re-open triggering a significant rebound in energy demand from low levels. Despite the recent jump in cases in certain US states, we don’t see that having a significant impact on the economy re-opening.
• China has led the rebound in demand, but now others in Asia, like Japan, are following. Europe and US are also now entering their re-opening phases.
• Concern around the COVID infection risk around using subway systems, and general public transport will likely see more use of cars as people return to work.
• As lockdown measures are loosened, we expect an increase in short term holiday travel specifically led by the US. However, rather than using domestic flights, people will likely use cars instead. This could see an upside surprise in demand coming during the US peak driving season. We could see potential similar experiences during European holiday season.
• On airline demand, we do expect some pick up from the lows as travel restrictions are loosened.
• We’ve seen unprecedented global oil cuts from OPEC which could come to 9.7mbd in May to July period, and 7.8mbd in the August to December period. North America is now expected to reduce production as much as 3.0-3.5mbd.
• Other global producers are closing high cost or offshore drilling. Some of the cuts could be unwound on much higher prices but a lot will take time and funding. They also have the potential to unwind hedges, and we find breakeven oil prices remain high as a lot of Shale producers were struggling even at $50-$60 oil prices before the onset of the pandemic.
• As noted in a piece by John Butler in April on Macro Hive, because of the elasticity of oil price we can see a major over shoot to the topside on the back of pick up in demand.
• WTI Oil Volatility like most assets has significantly sold off. Dec 25 Delta WTI Calls have traded down from a high of 67 in mid-April. This suggests there is value in using out-of-the money calls to express our bullish view.
• We like to buy Dec 2020 $48 Call on WTI (Delta 24).

John Butler has 25 years experience in international finance. He has served as a Managing Director for bulge-bracket investment banks on both sides of the Atlantic in research, strategy, asset allocation and product development roles, including at Deutsche Bank and Lehman Brothers.

Andrew Simon has spent over 25 years in finance on both the buy side and sell side. He co-founded Eschaton Opportunities Fund, a $100 mn+ hedge fund focused on global thematic value investing.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)