For most of 2018, the consensus for crude oil market was for prices to soar higher approaching the re-sanction of Iran by the Trump administration. However, such consensus was overturned in a span of two months during the recent October and November when $100 / barrel bullish thesis flipped around to $40 / barrel bearish thesis. This article is an executive summary of the crude oil market particularly West Texas Intermediate benchmark prices based mainly on observed fundamentals. Having said that, please feel free to contribute your constructive critique and evaluation if the article serves to assist in your understanding of the crude oil market. (No price range is provided as this is not a buy / sell call)

I) Topdown Analysis of the Crude Oil Market

1. Commodity assets are now trading at an unprecedented low valuation level relative to the S&P500, surpassing the record low in the early 70's Great Inflation era. Then, like now, central banks were behind-the-curve, making inflation-hedge assets prospectively attractive. Although recent market jitters caused temporary pullback in commodity prices, history has shown that commodities can outperform even when financial assets underperform. A decade ago, the S&P500 crashed by 40% from January 2006 until December 2008 yet Goldman Sachs Commodity Index grew by 60% as crude oil prices doubled.
2. The stock market rout from October flipped market sentiment from positive to negative, culminating in downward revisions of economic growth and crude oil demand growth globally. Nonetheless, the stock market is expected to stabilize in a sideway trading range in 2019 as Jerome Powell tones down his hawkishness to support the final leg of the business cycle. Additionally, President Trump's Iranian sanction waiver acted as a double whammy on crude oil prices. However, crude oil market long-term fundamentals stay intact and presents a compelling entry opportunity at current price. With collapsing non-OPEC conventional supply, the leap in the number of people around a period of accelerated demand from 700 million to 2.5 billion as India now enters its tipping point alongside China will bring about a severe supply deficit going forward.
3. Frequent underestimation of demand averaging 1 million barrel per day from 2009 until 2017 by the IEA had resulted in greater crude oil output cut than required and a collapse of more than half in upstream oil and gas capital expenditure compared to the peak in 2014. The world had consumed a total of 320 billion barrel of oil equivalent while global conventional discoveries only totaled 170 billion barrel of oil equivalent from 2012 until 2017. With a net loss of 230 billion barrel of oil equivalent reserves, the world lost an amount of reserve equivalent to Canadian oil and gas reserves, the third largest reserve globally. Even by assuming an optimistic 80 billion barrel of oil equivalent reserves for non-conventional resources in United States of America, global net loss of serve stands at a staggering 170 billion barrels of oil-equivalent.
4. Crude oil market is currently affected by short-term fundamental dislocation namely export-timing mismatch and highest planned refinery maintenance for the past four years. For the former, total crude oil export from Saudi Arabia and Iran steadily increased from 9.1 million barrel per day in March to 9.7 million barrel per day in June before declining to 8.6 million barrel per day by September as Iran exported 540 thousand barrel per day less compared to March. For the latter, the higher rate of growth in crude oil prices versus retail gasoline prices caused gasoline crack spread to turn negative, incentivizing refineries to conduct maintenance. However, export-timing mismatch will dwindle over the next few months as Saudi Arabia crude-in-transit collapsed. Similarly, gasoline crack spread is undergoing a trend reversal while distillate crack spread stays elevated. Already, U.S. refinery capacity utilization improved from its October low of 88.8% to its recent 95.4%. 
5. Electric vehicle (EV) will economically displace internal combustion engine (ICE) vehicle at a battery cost of $100 / kwh McKinsey predicts to be not achievable prior to 2025 based on 2017 crude oil price of $51 per barrel. To achieve competitive parity in the near-term, battery cost has to decline by half or crude oil prices have to double. In addition, petrochemical demand growth of 1.7 million barrel per day will be able to offset transportation demand displaced by EV to the extent that EV stock comprise 7.6% of global vehicle stock assuming CAGR ('17 - '25) of 57% for the former while the latter stays constant.

II) Bottom-up Analysis of the Crude Oil market

1. Saudi Arabia's spare production capacity of 1.5 million barrel per day in excess of its 10.6 million barrel per day of production now is non-existent due to declining reserves and inventory despite claims of the contrary. From 1987 to 1989, Aramco sharply raised its reserves from 170 billion barrel to 260 billion barrel. Since then, a cumulative 100 billion barrels were produced yet reserve figures maintained at 260 billion barrels despite there being no major discoveries since 1970. Interestingly, Saudi Arabia's crude oil inventory also declined by one-third from its peak recorded in early 2016, a conflicting observation for a nation that cheer on its spare production capacity. That leaves the world dangerously exposed to a severe supply deficit in the midst of rising demand growth.
2. Crude oil prices were oversold by the Iranian sanction import waiver as WTI is currently trading below the $60 level when the re-sanction was mentioned in spring. Compared to the previous six-month average, the total waiver capacity ratio to total imports for all customers averaged at only 62%. Applying the ratio to Iran's highest export figure so far in April 2018 of 2.5 million barrel per day will only yield 1.6 million barrel per day yet it is odd that part of the market strongly believe that Iranian crude oil export can significantly exceed 1.6 million barrel per day due to this waiver. Even if Iran is assumed to be able to export 2.5 million barrel per day indefinitely going forward, a raged Saudi Arabia will call for an OPEC+ output cut of 1.4 million barrel per day. In that case, the world will experience a 400 thousand barrel per day cut in the context of September's industry dynamic when crude oil prices were rising as the 900 thousand barrel per day increment in Iranian export is offset by the 1.4 million barrel per day cut by OPEC+.
3. Geopolitical risk to potentially remove total supply of Iraq, Nigeria and Libya in 2019 by 370 thousand barrel per day in the base case and 1.15 million barrel per day in the bull case, representing 0.4% and 1.2% of 2017 global supply. According to RBC estimates, Iraq is set to lose 120 thousand barrel per day to 300 thousand barrel per day in 2019 compared to September 2018 as social unrest intensifies with protestors targeting oil facilities. Meanwhile, Libya is set to lose in between 250 thousand barrel per day to 850 thousand barrel per day in 2019 compared to September 2018 as political election risk rises. Similarly, Nigeria can hypothetically lose 250 thousand barrel per day in 2019 compared to September 2018 if a change of government occured in the upcoming election as the Niger Delta militants may resume attacking oil infrastructure during the renegotiation period with the new government.
4. Venezuela's production will collapse further as state-owned PDVSA is trapped in a debt overhang and political interference that requires 32% of crude oil produced to be used for debt repayment and 24% of crude oil produced to be sold domestically at a loss. Both factors causes low cash flow, causing payables to suppliers to pile up, incentivizing oil and gas service companies to rush for the exit while existing oil rigs decline in efficiency. As Russia and China are the main creditors, the crising clout of both nations in Venezeuala is causing an exodus of Western joint venture projects responsible for 30% of Venezuela's total production in 2017. Rystad Energy estimated Venezuela's rig count needs to double or triple from current 26 to normalize the decline of mature fields which constitute 61% of total production. Venezuela is expected to produce below 1 million barrel per day of crude oil and is likely to collapse to 700 thousand barrel per day in 2019, a 44% decline from 3Q18 production for a nation with the largest hydrocarbon reserve.
5. Petrobras had a consistent history of production target overestimation, with BCA forecasting 2019 production to be 300 thousand barrel per day lower than consensus and 200 thousand barrel per day lower than company guidance. BCA, with the best forecasting track record during the past decade predicated on an expectation of a repeat in production target overestimation by Petrobras. Meanwhile, Petrobras can possibly meet its 2019 production target this time around as historical multi-year investments come into fruition while the consensus believe prior investments can be reap much more aggressively than what is laid out by Petrobras. Assuming Petrobras produces 83% of Brazil’s total production, Brazil would be producing 2.8 million barrel per day, 3 million barrel per day and 3.15 million barrel per day under BCA, Petrobras and consensus estimates. Although both BCA and Petrobras estimates have high likelihood, the consensus will be caught on the wrong side of the game. As deep-water development remains challenging, IEA already revised downward Brazil’s output growth for 2018 by 90% from 260 thousand barrel per day to 26 thousand barrel per day and such difficulties are expected to persist into 2019 
6. At the beginning of 2018, total production of crude oil from both Norway and UK were expected to grow as extrapolation occurred from a spike in production from 2015 to 2017 primarily brought about by the commissioning of large projects such as BP’s Quad 204. However, the last four quarters (17Q4 – 18Q3) witnessed an average production decline of 122.5 thousand barrel per day, a 4% decline when comparing to the preceding four quarters. Albeit influence by weather, field exhaustion seemed to be another culprit given observation of persistent field maintenances. By referring to Hubbert Linearization, it is evident that the North Sea had passed peak production almost two decades ago. Similarly, unplanned maintenance usually brought upon by aging infrastructure due to collapse in upstream capital investment such as the closure of Forties pipeline in Dec 2017 will occur at higher frequency going forward. Therefore, UK and Norway’s total crude oil production is expected to decline by 2% YoY or 60 thousand barrel per day to 2.85 million barrel per day in 2019, in-line with IEA forecast 
7. President Putin and Russian Minister of Energy Alexander Novak explicitly declared that Russia aims for crude oil price range of $65 to $75 per barrel based on BRENT ICE benchmark. The bottom limit is explained by Russian government requirement of at least $65 per barrel to breakeven in its fiscal expenditures while the upper limit is made for the following reasons. Firstly, Russia does not want high oil price because it does not want to revive North American shale play while incentivizing investment into alternative energy. Secondly, Russia is trying to diversify its economy away from over-reliance towards crude oil revenue. However, Russia provides more downside support than upside cap because the nation had already reached close to its output limit. According to Alexander Novak, Russia can boost its crude oil output by another 200 thousand to 300 thousand barrel per day within several months from its record production of 11.36 million barrel per day in September 2018. Therefore, Russia would not have sufficient spare capacity in the case that global demand grew aggressively, which is one reason Russia is more hesitant towards Saudi Arabia’s output cut plan. With BRENT ICE currently trading at $60.22 per barrel, an asymmetrical risk & return profile has emerged. 
8. The prowess of U.S. non-conventional crude oil supply that constitutes 66% of production is contingent upon continuous growth in the Permian basin picking up declining growth from Eagle Ford and Bakken basin due to Tier 1 acreage exhaustion among the latter two. Such hypothesis is proven by the observation that current rig count as a proportion of peak rig count in 2015 for Permian, Eagle Ford and Bakken are an impressive 86%, and poor 34% and 28% even as crude oil prices rallied continuously in the past two years. MIT researches concluded aggressive growth in Bakken and Eagle Ford in low crude oil price environment was due to focus on Tier 1 acreage drilling and that the near-term shift to Tier 2 acreage will cause production to grow by only mid-single digit of 6.5% versus historical double-digit growth. Therefore, Eagle Ford, Bakken and other shale basins excluding Permian is expected to grow production to 1.4, 1.36 and 1.1 million barrel per day in 2019. Although EIA forecast 3.9 million barrel per day of production for Permian, pipeline takeaway capacity will cap Permian’s production at 3.6 million barrel per day for 19H1, mandating a production level of 4.2 million barrel per day in 19H2, a feat with extremely high hurdle rate. As for U.S. conventional crude oil supply, McKenzie and EIA predict Gulf of Mexico (GoM) to grow 14% YoY in 2019 to 2 million barrel per day underpinned by enhanced production technologies, favorable revision in royalty rate and tax overhaul. On the other hand, U.S. conventional crude production ex. GoM will be flat given its general declining trend due to field exhaustion with 2019 production figure of 1.8 million barrel per day. Altogether, U.S. is expected to produce 12.1 (EIA) or 11.6 million barrel per day in bear and base case, driven predominantly by the three large shale basins. 
9. From 2003 until 2008, IEA has constantly underestimated Chinese oil demand on average by 300 thousand barrel per day annually. Today, like then, IEA will underestimate Indian oil demand by relying on a linear growth model instead of a non-linear-curve growth model as India reaches its curve tipping point where oil demand starts growing exponentially. For instance, South Korea reached its curve tipping point in 1985 when per capita income grew by 2x yet oil demand grew by 3.5x over the next decade, a stark contrast in the preceding decade when income doubled but oil demand only grew by two-third. In the case of India, the two key drivers of oil demand going forward will be increasing urbanization and expanding transportation infrastructure. At 33.5% urbanization rate, India is now very similar to China in 2000 and South Korea in 1970 when urbanization rates were 36% and 40%. Compared to China back in 2005, China’s expressways are 32x longer than India, and that India has 15x more citizens and 31x more vehicles per mile of expressway. Being aware of its own transportation infrastructure bottleneck, the Indian government plans on increasing its expressway length by 14x from 2017 until 2023. Post increment, there will still be 100,000 Indian citizens per mile of expressway, twice the level of China back in 2005. Assuming India follows China’s model, oil demand will double from 2017 until 2027, growing by an average of 480 thousand barrel per day annually, 2.3x IEA’s 2019 oil demand growth forecast. In the bull case, India will follow South Korea’s model and grow demand by 740 thousand barrel per day in 2019 while IEA’s forecast is taken as the bear case. As for China, IEA’s 2019 forecast is utilized for both bull and base case yet bear case is assumed to be 1.9 million barrel per day lower at 11.56 million barrel per day, the equivalent of 2015’s oil demand when the Chinese economy faltered temporarily. Simply speaking, IEA will have to revise its 2019 demand forecast by -1.9, 0.26 and 0.52 million barrel per day for our bear, base and bull case with differences mainly stemming from both nations. 

III) Additional Catalysts

1. On 1st January 2020, the International Maritime Organization (IMO) will implement a new regulation for 0.5% global suphur cap for marine fuel. Based on various estimates, this is expected to transfer close to 2 million barrel per day of demand from heavy sulphur gas oil demand to low sulphur gas oil. Since heavy sulphur gas oil is a by-product of final refinery processing in contrast to low sulphur gas oil which needs to be reprocessed both from atmospheric, vacuum and coker, the demand impact from both sources towards raw crude oil are different. Given that the maximum distillate proportion a refinery can produce is 50%, a demand transfer of that magnitude will mandate 4 million barrel per day of incremental demand for crude oil.
2. Often not discussed by the financial market, the biggest hield yield group in the corporate bond world of U.S. is the oil and shale drillers. Altogether, they make up about 16% of the category and just under 19% of those companies rated CCC or below according to Dealogic data. As most will have to refinance their debt from 2019 until 2023, the breakeven price will escalate due to higher interest rate. Moreover, the decline in Tier 1 acreage had caused shale drillers to increase propant loading. With propant prices such as sand increasing from $25 / tonne in 2016 go $75 per tonne currently, it remains interesting as to how U.S. shale majors can further decrease their breakeven cost. In addition, the recent oil price crash have caused many oil majors in U.S. to slash capital expenditure and similar issues were ongoing in Canada that recently announced a production cut.