Oil sell-off: The market priced in ‘double the Delta hit’ for the Omicron variant, strategist says

Goldman Sachs Senior Commodity Strategist Damien Courvalin joins Yahoo Finance Live to discuss the unpredictability of oil prices due to inflation and Omicron concerns.

Video transcript

BRIAN SOZZI: All right, let's stay on all things prices here. US crude oil prices are down 16% from their late October high of roughly $71 a barrel. Gas prices have also eased in recent weeks, dropping to a national average of $3.34 a gallon from $3.42 a gallon in November. But will these declines persist? Damien Cleveland is Goldman Sachs' head of energy research and senior commodity strategist and joins us now. Damian, always nice to see you. So can these declines, how much longer can they persist?

DAMIEN COURVALIN: Hi, Brian, great to be back. So if you think about the big move lower, you really can tie it to the fear over the latest COVID variant. Oil always gets hit the worst across assets because it's always restrictions on mobility. So right now, we're still learning more about this variant, and that's weighing on oil prices. What I think is very important to point, however, is the move lower, that 60% sell-off that you mentioned, has already priced in a relatively bad outcome.

So, to put in perspective, it's equivalent to no plane flying around the world for three months. If that's the case, we have a recession, right, given how much cargo flies. Put another way, it's pricing double the delta hit this summer in Asia, plus double the alpha wave in Europe last winter, plus flying going back to pre-vaccination levels. So because of lower year end liquidity, we've overshot. We believe we're going to move higher from here. Timeline wise, I would argue we need just to know a bit more about the virus exactly in terms of virulence and spread.

BRIAN CHEUNG: Hey, Damien, it's Brian Cheung here. But let's talk about the supply side of things, OPEC Plus announcing that they're going to continue to ramp up production in January next month. So how do you think that's going to weigh on prices as we see them right now?

DAMIEN COURVALIN: Yeah, it was indeed, Brian, a bit of a negative surprise. We thought they would freeze consensus, thought they would freeze. I mean, it's not a big number, right? It's not even a tenth of what the demand hit that's been priced in by the market. You know, I think the timing, though, is interesting and suggests that there probably was some desire to kind of go with the US, ask for more supply.

Year end is always when US producers also budget for production the following year. And OPEC had, for years, kind of made the mistake in a sense of coming out the bullish decision in December. And it would just embolden US producers to grow more aggressively the following year. Today, you flip that script. US producers are still cautious and that OPEC decision probably fits within that state of mind.

Again, does it change anything big picture? No, it's small volume. You know, OPEC on aggregate can't even deliver those volumes every month. It's starting to fall behind. So it doesn't change the overall picture. But it just adds to that kind of year end uncertainty and poor trading price action.

JULIE HYMAN: Damien, it's Julie here. We've seen the volatility of oil tick up like we have for stocks and pretty much for everything. And it's come back down again, just like we have seen for other assets. What are you expecting from volatility going into year end and then into 2021, as we still-- I mean, a lot of what we're talking about is not necessarily going away, perhaps with the exception of the peak of omicron concern.

DAMIEN COURVALIN: You raise a good point. I mean, in fact, I think volatility in oil outperform every other asset classes on that significant sell-off we had 10 days ago. We actually had volatility at financial crisis levels in the oil market. Now, it's not, again, so much about how big that fundamental shock could be. It reflects year end lower liquidity. It also reflects the inherent nature fabric of the oil market where producer hedging can at times exacerbate such moves. We had that in 2018, for example. We had that in 2014. So, something a bit idiosyncratic there.

Volatility fundamentally persists in the short run, right? We don't exactly know where this variant is heading. However, I think what is key for 2022 is that despite this kind of short-term uncertainty, the medium-term direction is relatively clear, right? Demand will continue to recover unless this is a dramatic variant, which doesn't appear to be the case.

And what will become more important is the supply not ramping up, right? I think that's the key. 2021 was a cyclical bullish trade. Now we're making the transition, and albeit volatile transition, to a structural story, which is we also consume oil every day, but we're not producing enough medium-term to meet that demand. So year end volatility high, but we're making a transition to what I think will be a relatively straightforward move higher next year.

One last item that, you know, keeping us on our toes is Iran, right? Iran is a source of potential additional supply. And so we're keeping an eye on the discussions now. It does appear it's moving later in the calendar, and that would be supportive of that view of higher prices into 2022.

BRIAN SOZZI: Damien, the recent tick down in oil prices, even natural gas prices, what does that mean to the budgets, the Capex budgets for some of these oil majors, like an Exxon and a Chevron?

DAMIEN COURVALIN: I think, you know, it's part of the inherent volatility. And producers never budget on the spot price, right? They kind of look through and assume in their budgeting always lower prices than where we peaked. I do think, though, it fits into their cautious approach to spending into capex, right? They've had a few quarters of very good financial results. They're paying dividend, buying back stock, buying back debt. Investors are finally stepping back in.

But this is just the early innings, right? I think that discipline and returning cash to shareholder pattern has to persist, which inherently leaves them cautious on ramping up activity. The big sell-off, right, plays into that more cautious Capex budgeting, which is what you saw from Chevron and Exxon when they announced their medium-term Capex plan. They were on the cautious side.

JULIE HYMAN: Hey, Damien, Brian there going to the corporate side of the equation. I'm going to go to the other side, to the consumer side of the equation. And I know you think about these things at a very high level, right? But I'm curious, especially as we talk about CPI today and concerns over people paying higher prices, it sounds like, if I distill everything that you're saying, that we cannot necessarily expect much relief at the pump into next year, at least not here in the US.

DAMIEN COURVALIN: I think that's the right conclusion, right? We've had relief now we had of this unexpected variant. US administration added some extra barrels, and OPEC is. Those are all transient solutions to a persistent problem, which is now, for the longest time on record, we're consuming more than we're producing. That started in June 2020, and we're still in that state today.

And as we look through 2022, that's still the case. So the market actually requires higher prices to balance, right? For us to have affordable gasoline, and that's still expensive, but managing expensive gasoline in the next few years, we actually need to see that sustained high price environment that gets the corporate to spend. That goes to Brian's question, right? The producers need to see that incentive, that pathway to ramping up Capex. The sell-off we've had doesn't create that incentive.

BRIAN SOZZI: All right, we'll leave it there. Damien Courvalin, Goldman Sachs' head of energy research and senior commodity strategist, always appreciate your insights. Have a great weekend.