China reopening ‘a sentiment positive’ for oil, strategist says

CIBC Private Wealth U.S. Sr. Energy Trader Rebecca Babin joins Yahoo Finance Live to discuss China reopening, EU sanctions packages, and the outlook for oil markets.

Video Transcript

- Oil prices have cooled recently, erasing their gains for 2022, but our next guest says the two key things that will determine the fate of crude in 2023, China demand recovery and Russian supply sustainability. CIBC Private Wealth US senior equity-- energy trader, excuse me-- Rebecca Babin joins us now. I'm so used to saying equity, Rebecca. Thanks so much for being with us. Appreciate it.

I want to talk about the China piece of the equation first, because we are now seeing China actually kind of open up even more abruptly than had been anticipated. So how is that, because it seems a little choppy, going to affect the picture as we get into next year?

REBECCA BABIN: So that's the big question, Julie. You totally nailed it. China reopening more quickly is a sentiment positive because it means we're obviously going to see demand increase. Demand has been compressed by an additional million barrels from September due to China's most recent lockdowns. That's a huge number. A million barrels of demand loss equates to, back of the envelope, around $15 a barrel in crude. Right? So if we bring that back, you're going to see a huge tailwind in the commodity.

The reopening trade, however, is not going to be linear. And the sentiment lift we got when the reopening was initially announced in crude kind of fizzled last week on this idea that we may actually see demand get hit initially as cases spike and people decide to actually stay home because they don't want to get sick or because they are getting sick. This is going to be a positive trade in 2023 for China. The question is, how does it play out over the course of between now and then? And it's going to be choppy.

I will say this, though. If you look at the high-frequency data coming out of China right now, mobility data is actually increasing. And some of that sentiment shift we saw last week I think was an overreaction to potentially, oh my gosh, it's-- the hospitals are going to be overrun, et cetera, which we still may see, but right now, the high-frequency data is showing some improvement on easing of some of the restrictions.

- Rebecca, energy equities have outperformed massively this year when compared to pretty much any part of the market. And so where does that set up going into 2023?

REBECCA BABIN: That's a great question. And that's a battleground topic, as I would call it. There's so many people out there who are looking at energy outperformance not only relative to the rest of equities, but relative to the commodity. They've outperformed the commodity by 30%, in some cases. And saying, hey, have they already priced in the best-case scenario coming out of China and Russian supply disruptions, and do they have the potential to continue to perform, and do they catch down to the commodity or does the commodity catch up to equities.

I would say this. I think it's going to be a harder trade in 2023, but I think it's a trade that can still work, based on the fact that these companies are not making rash decisions about increasing production when the crude-- when crude rallies. They are less levered, they are more disciplined, and they are super focused on returning cash to shareholders. Now, obviously, there is execution risk here, and it's not going to be as easy of a trade. But in my view, based on valuations, energy stocks can continue to trade really well. Now, I don't know if they're going to outperform the rest of the market the way they have this year, but I think there's a long-term, 2023 to 2024 structural trade in US energy equities that will produce good results.

- Rebecca, more short-term in nature, of course it's smack in the middle winter season. Storm activity is starting to pick up. Are you seeing any crowded trades right now in the commodity space?

REBECCA BABIN: You know, that's a good question. No, because I'll tell you this. In crude-- and I'll speak to crude specifically, where I'm most knowledgeable-- positioning has been decimated over the last two weeks. We've seen open interest fall. We've seen net long length in the market come down significantly. So if anything, I think positioning is very light and set up for kind of a coiled spring rally if we get any kind of positive data point.

Maybe-- and I did see retail buying the USO ETF last week-- maybe we're seeing retail start to nibble, which can be a little bit of a contrary indicator. But honestly, the products, the crude oil positioning seems pretty light to me. Maybe in that gas, you have some over positioning there. But as far as I'm concerned, I don't see a super crowded trade in the commodity right now.

- That's very interesting. We didn't get as much into the Russia side of the equation. So just briefly, and sort of in layman's terms, if you can, what is the risk to the up and to the downside as we go into 2023 coming from Russia?

REBECCA BABIN: Yeah, so the risk for 2023, the risk to the upside is that Russian flows are impacted by the next round of sanctions that take place in February. These are product sanctions, diesel and gasoline that are flowing into Europe. Those are around 800,000 to 1 million barrels. Those are much harder to find alternative buyers for, so there is a chance that, when those sanctions kick in, Russia will be forced to shut in some production and remove some supply from the market. That's the really big catalyst. That would create upward trajectory for crude.

On the other side of that, though-- and I think it's good to highlight the downside-- we've seen softening of sanction language going into each round of the implementation of sanctions. And should language soften around that and the EU kind of make provisions to allow products to continue to flow to the market because they don't want to see these price spikes, you could see-- I think the setup for February is people expect a million barrels to come offline. And if that doesn't transpire, we could have what happened just after the December 5th sanctions, where you have this letdown if that doesn't happen. I tend to think we will see a disruption of around 500,000 to 700,000 barrels on the Feb 5th sanctions, just because Europe has been pretty unified in wanting to push forward with their sanctions packages.

- Rebecca, it's always great to catch up with you, and good to look ahead to 2023. Thank you so much, Rebecca Babin of CIBC. Happy holidays, Rebecca.

REBECCA BABIN: Thank you. Have a great day.