Cheers everyone!
The range-bound price action continues as we head into the summer driving season. To have any bullish momentum we need to first clear $74. Above there, the direct price action to $77 is almost guaranteed. Today, we will go through a quick lesson on how to kill oil prices to help inflation and the global state of crude oil.
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IEA
Weak, lethargic and disappointing. In regard to the present economic outlook, this is what pessimists would have you believe. Concerns about the health of the global economy and the outlook for oil demand have recently dominated the energy markets. We have long argued that the bearish price action is unjustified, and yesterday's IEA monthly oil report reiterated this sentiment. The Paris-based agency anticipates that global oil demand will increase by 221,000 bpd in 2023 to an average of 102 mbpd, which is 180,00,000 bpd more than its previous prediction. In addition, global oil consumption is anticipated to reach a record high of 103 mbpd in August.
The improving outlook for demand growth hinges on, you guessed it, China. In March, the demand side of the oil equation was led by the Asian colossus, whose oil consumption reached a record high of 16 mbpd. The IEA now anticipates annual growth of 1.3 mbpd in China in 2023, compared to April's projection of 1.1 mbpd and March's estimate of 900,000 bpd. In light of the fact that China's recovery is proving to be stronger than anticipated, it is widely anticipated that gains will accelerate for the remainder of the year. Briefly, the IEA contends that the optimistic outlook for China's oil consumption should allay concerns about a decline in oil demand growth.
On the supply side, the most important takeaway was the sustained resilience of Russian oil supply. According to the IEA, Russian oil exports reached a post-invasion high of 8.3 mbpd in April. This is in contrast to the average of 7.7 mbpd in 2022 and 7.5 mbpd in 2021. Such massive shipments will raise fresh doubts as to whether Moscow has fully implemented its pledged 500,000 bpd supply cut. According to the IEA, Russian crude oil output remained unchanged at 9.6 million barrels per day, implying that the OPEC+ heavyweight must still reduce production by an additional 300,000 barrels per day to conform.
In spite of Russia's persistently high output, OPEC+ output is anticipated to plummet this month as a result of voluntary production cuts. According to IEA projections, OPEC+ oil production will decrease by 850,000 bpd between April and December. Moreover, it is anticipated that flows from outside the producer group will increase by 710,000 bpd. Consequently, the IEA increased its 2H23 forecast for OPEC crude by 100,000 bpd to 30.35 mbpd. The cartel's production was just below 30 million barrels per day in April and is expected to decline further this month as a result of new cuts.
The result is a tightening of market equilibrium. The global supply and demand balance for 1Q23 indicates a stock build of 870,000 bpd, the fourth consecutive quarterly build. Now, however, substantial stock withdrawals are anticipated from the current quarter through the end of the year. Demand will exceed supply by nearly 2 mbpd in the second half of the year, according to IEA balances. Simply stated, a supply shortage looms in the near future. And you can be certain that oil prices will increase once the markets realize this.
RISK OFF
Yesterday, most people didn't pay much attention to the IEA's optimistic predictions because economic news from China and the US was worse than expected. In April, retail sales and industrial production in China did not pick up as much as was predicted. Also, US consumer spending was lower last month than was expected. Retail sales went up by 0.4% in April, which was less than the 0.8% rise that was expected. This came after a 0.7% drop in March. A measure of the mood of German investors fell more than expected this month, which suggests that Europe's biggest economy could go into recession this year.
There were still worries about the US debt limit, even though the macroeconomic news wasn't very exciting. Negotiations to raise the debt cap are still going on, but so far they haven't led anywhere. With only 15 days left until June 1, when the US is likely to run out of cash, worries about a possible default are only going to grow. In the US, API figures released late last night showed that crude stocks went up by 3.6 million bbls last week. Gasoline and diesel fuel stocks fell by 2.5 million bbls and 886,000 bbls, respectively.
HOW TO KILL OIL PRICES
Today's recipe will show you how to lower oil prices by $10/bbl. Start with a lot of inflationary pressures, add a dollop of rising interest rates, a sprinkle of trouble in the US banking system, a spoonful of worry about a possible US default, and a dusting of weak Chinese data to finish. Mix well, put in the oven for four weeks, and done!
Bullish people have had a rough time over the past month or so, and last week was no different. Both crude gauges lost money for the fourth week in a row. This is the longest week-to-week losing streak since November 2021. Because of the recent drop in oil prices, positive predictions have had to be rethought. Sure enough, the smartest and best people on Wall Street are leading a wave of downward changes. This month, Morgan Stanley, Citi, and BofA all cut their predictions for the price of Brent in 2023. Even the most optimistic people at Goldman Sachs are losing faith in oil. They don't think Brent will hit $100/bbl in the second half of 2023 as they once did. Those who were hoping for oil prices to go back up to triple digits have been dealt a big blow. In the EIA's short-term energy outlook for May, the average price of Brent crude oil in 2023 was dropped from $85/bbl to $78/bbl. This was a big change from April, when the average price was predicted to be $85/bbl.
The oil market hasn't been able to get rid of its negative bias because of worries about demand caused by worries about the economy as a whole. And because people at the front of the oil curve are worried about prices going down, shorts are back in a big way. In fact, exchange records showed that short sellers are back in charge of the market. Money managers cut their net confident bets on the world's most important crude oil futures and options contract by more than half in the three weeks leading up to May 9. During the time period, net long holdings in ICE Brent fell by 129 million barrels, reaching a 2023-year low of 122 million barrels. Both sides of the trading coin led to the bankruptcy. Gross longs went down by 63 million bbls, while gross shorts went up by 66 million bbls to go above 100 million bbls for the first time since June 2021.
Traders have stopped making positive bets, so oil prices can only go down. But from where I'm sitting, the sale looks like it's too late. The author is ready to bet that other people feel the same way. It's hard to find a good reason why the oil markets are getting more bearish. The fact is that the price of oil is not in line with what we know about it. So, there's no question that oil prices are well below what most people would say is a fair price, and it's only a matter of time before they go back up.
Even though there is a lot of worry about the demand side of the oil equation, the future is still good. The EIA raised its expectations for growth in demand for this year last week. In the meantime, OPEC kept its predictions of strong demand. When the IEA updates its demand projections tomorrow, everyone will be watching to see if it agrees with this confidence. As of now, the global economy is still going strong, and demand looks good for the near future.
On the supply side, new cuts by OPEC+ show that the group is serious about keeping the $80/bbl price floor in place. With non-OPEC sources staying about the same, this should keep supplies tight for the next few months. In fact, big stock draws are planned for the second half of the year, which will help keep oil prices high.
Since the market will be at a loss starting next month, the current bad mood won't last much longer. Prices are about to go up, which is a better way to say it. The latest price polls from Reuters and Bloomberg agree that Brent will average $87/bbl in 2023, which backs up this feeling. So far, the average price of foreign crude has been $81/bbl.
The comeback will be helped by the fact that demand is strong at this time of year, that OPEC is holding back on supplying, and that stocks are going down. In short, there are a lot of things that will help in the future. Even so, most people in the market still don't care about rising bullish balances. This puts them at risk of being caught short when Brent prices go back up to $80/bbl and then $90/bbl at the end of the year. George Harrison sang, "All Things Must Pass," and the drop in oil prices is a good example of this.
Above, it's easy to see why our cynical selves might want to make a big downward revision in oil prices. It's because the overwhelmingly bullish fundamental background is being ignored for now, and investors are nervous about taking risks because of high borrowing costs and brewing credit and debt crises. Oscar Wilde said that a cynic is a person who knows the price of everything but not what it's worth. On the other hand, our practical selves are sure that supply and demand will win, that oil is cheap going into the second half of the year, and that stubborn bears will eventually give up.
The updated OPEC prediction is so price-supportive that it's almost scary. Even though the world's oil stocks will have grown by 430,000 bpd in the first half of 2023, the trend will quickly change in the second half. The amount of oil used around the world will hit a record high, and the producer alliance will cut production, first as part of its supply management strategy and then partly because smaller producers don't have enough capacity. From the first half of the year to the second, demand for OPEC oil will go up by 1.65 mbpd, and global oil stocks will go down by 1.18 mbpd, or 880,000 bpd in 3Q and 1.48 mbpd in 4Q. Historical data shows that around 40% of global stock movements happen in the developed part of the world. This means that OECD trade inventories, which have a high negative correlation with the price of Brent, will also be depleted. The most recent estimate says that they will drop to 2.796 billion bbls between July and September and 2.742 billion bbls by the end of the year. Current stocks in the rich part of the world are more than 2.8 billion barrels.
This optimistic view is supported by projections made between 2011 and 2013 (using data from OPEC) when OECD inventories were just a little bit below the level expected for the second half of 2023. At the time, the price of Brent varied between $100/bbl and $130/bbl, which is a lot higher than it is today. This was helped by the fact that the dollar was weak at the time. Ten years ago, its index against six big currencies traded between 73 and 85. Now, it's at 102. To compare apples to apples, it makes sense to look at how stocks and prices changed in the second half of these three years and how the oil balance is likely to change in the second half of 2023. The most obvious reason is that during these quarters (3Q and 4Q of 2011/2012/2013), the average price of front-month ICE Brent was between $109 and $112 per barrel. This is different from the present curve, which is between $74.50 and $73.50 per barrel. Except for the third quarter of 2012, world oil stocks dropped between 100,000 bpd and 1 mbpd, which was less than what was expected for the next six months.
OECD oil stocks were smaller than what was expected for the second half of 2023. They ranged from 2.565 billion bbls in the fourth quarter of 2013 to 2.728 billion bbls in the third quarter of 2012. So, it makes sense to expect oil prices to average below the $109-$112/bbl range stated above. How much further down? Based on a seasonal comparison of OECD inventory levels and Brent prices, Brent prices should jump to $88.30/bbl in the third quarter and $90.90/bbl in the fourth quarter of 2023, which is significantly higher than the 3Q-4Q curve.
Another interesting thing about the link between OECD stocks and Brent prices is that every time stocks went down in the second half of the year compared to the first half, Brent prices went up on average in the second half of the year. In the last 15 years, it has happened six times. So, it makes sense that prices in the second half of the year should be higher than what we have seen so far this year, which is just above $80/bbl.
The stage seems to be set for oil prices to go up with confidence unless oil demand drops sharply, the producer alliance doesn't follow through on its promise, and the expected drop in stocks doesn't happen. Most of the good news, like record demand and OPEC+'s plan to set a floor price, is already in the market. So, when economic headwinds are downgraded to a breeze, investors will be more hopeful that the thought depletion of oil inventories, which is a result of rising demand and falling production, is becoming true. This change in attitude is likely to happen when the risk of the US going bankrupt can no longer be undone.
Relief Rally
After four weeks of oil going down in price, the new week began with a boost. Part of the drop back down was caused by problems with supply. Oil flows from the two biggest countries in the OPEC+ group are said to be going down. Based on statistics from industry sources, Reuters figures that Russia shipped 11,383 million tonnes of goods by sea in April, which is 5% less than the month before. From April's average level, gas exports to Europe fell by 11% in the first half of May. Tanker tracker Kpler thinks that Saudi Arabia will ship out 6.48 mbpd of crude oil in May, which is 1.1 mbpd less than last month. Energy Intelligence found that OPEC+ countries with quotas produced about 2.6 mbpd less than their combined ceiling in April. Even after Iraq's output returns to normal (the latest cut went into effect at the beginning of the month), this is not expected to change much.
WTI and Brent both went up by more than $1/bbl, and RBOB ended the day $3/bbl higher. The latest drilling report from the EIA, which showed that US shale production hit a record high of 9.33 mbpd in June, only caused a brief drop after the settlement. The weaker dollar and the rise in stocks helped the move up. This may be a vote of trust that the US won't go bankrupt. Until the whole picture is clear, risky assets could keep going back and forth like they did this morning. The U.S. Department of Energy's plan to rebuy 3 million barrels of SPR crude for delivery in August and a good jump in China's April refinery throughput sparked an early rally. However, lower-than-expected industrial output and retail sales in the world's second-largest economy are putting a damper on the market. Even though the current investment climate is not entirely positive, one thing seems clear: the bottom end of the medium-term trading range, which is around $70/bbl basis Brent, is not likely to be broken, and the upper end, which is around $85/bbl and above, will be tested sooner or later.