Markets have a funny way of being symmetric. Weeks leading up to July 2015, the finalization of the Iran nuclear deal sent energy stocks and oil prices tumbling.
Source: WSJ Article
This week saw President Trump appoint possibly the most Hawkish politician on Iran foreign policy, John Bolton, to be the new National Security Advisor. The appointment of John Bolton along with former director of CIA, Mike Pompeo, likely foreshadows the end of the Iran nuclear deal. On May 12, President Trump will decide whether he will sign off the Iran deal, and all signs point to his unlikeliness to do so.
Why will this be important?
In our discussion with institutional money managers over the last 2 weeks, we uncovered how most investors have two big concerns in the market right now.
1) Will US shale push the global oil markets into oversupply?
2) What will happen to the Iran nuclear deal and as a result, OPEC’s production cut?
In our opinion, the US shale question will be answered in short order when US crude storage continues to fall materially even in the face of higher shale production. This will be enough to make people question whether US shale will be able to push the market back into oversupply.
But it’s really the Iran nuclear deal that could set off the catalyst we need for people to start panic-buying energy stocks. Bringing this back to section 1 of our write-up, investors seem to operate in this imperfect world of information. Theory of reflexivity also states that all one needs is just a slight change in perception and the price action will manifest upon itself.
Previously, investors thought Iran would be able to increase oil production in the future and possibly upending the OPEC production cut agreement, but with sanction risks back on the table, will this change perception? Yes, we believe so.
When we spoke to the institutional money managers, there was overwhelming agreement that the end of Iran nuclear deal would impact supplies. No one knows how much, but if our understanding of the market is right, it will be the exact polar opposite of what happened in June-July 2015. Investors will buy first and ask questions later. This reflexive feedback loop will usher in other investors into the sector and start a cascading effect of buying.
Simultaneously, May 2018 will also coincide with the start of massive US and global oil storage draws. All of this will come in the face of higher US shale production and force analysts to question the “lower for longer” thesis. In addition, OPEC and non-OPEC are expected to meet in May to extend the production cut to the end of 2018, and if our analysis is right, Saudi will reiterate that they have no intention of flooding the market again and keep the production cut largely the same. (Again, our reasoning is that they can’t increase production.)
In addition, we have also written here why we believe Saudi will further increase the supply shortage in the second half of 2018 via lower crude exports to “shock market participants out of the lower for longer” theme right before Aramco’s (ARMCO) IPO.
All of this lines up to be almost a “perfect storm” for energy equities.
Will the collapse of the Iran deal be the trigger we sorely need for the sentiment flip in energy stocks? It’s increasingly looking like it will be.
NOTE: This piece was first published to HFI Research subscribers on March 25th as part of our flagship weekly report. Here was the table of contents for that week's flagship report.
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Disclosure: I am/we are long OIH, XES. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.