Where is OPEC and the SPR Restock? Oil recap
Cheers Everyone!
What a wacky last few weeks we’ve had in the markets. We’ve had bank runs, oil back below $70, more interest rate hikes. It seems like every headline coming out is a major headline. For oil, all eyes continue to look at the OPEC meeting in a few weeks. Rumors are circulating that OPEC wants to make additional cuts to the supply supporting prices back to $80. At the same time, the SPR restock has yet to commence. Now what?
We lost our major support and since then, we have just been chopping around. Our opinion is when the Biden administration starts accumulating down here, we should get ourselves back in the $70 range soon.
SPR Restock? A dangerous scenario
On Thursday, interest rate decisions grabbed center stage once more. A day after the Federal Reserve raised interest rates to their highest level since 2007, central banks in Norway, Switzerland, and the United Kingdom announced another wave of monetary tightening. Yet, unlike the US Federal Reserve, they warned of additional rate hikes to combat inflationary pressures. The Fed is largely regarded to be on the approach of pausing its sequence of rate hikes. The differing rate outlooks of the Federal Reserve and the world's other major central banks are weighing on the US dollar. Nevertheless, the dollar index plummeted for the sixth consecutive session Wednesday, reaching a new seven-week low. Simply put, dollar bears are in control.
Oil prices extended their recent climb on the basis of a weaker US dollar. Rising pricing pressures were bolstered further by positive demand statistics from India. According to data released yesterday, India's crude oil imports increased 8% year on year last month, as fuel demand reached its highest level in more than two decades. Nevertheless, the two key crude indicators reduced earlier advances, ending a three-day winning trend. Jennifer Granholm, the US Energy Secretary, was to blame for the change in fortunes. She suggested that replenishing the country's strategic oil reserves could take several years. Washington has already stated that it will replenish the SPR, which is currently at its lowest level since 1983, when US crude prices were $67-$72/bbl. Yet, it appears to have moved the goalposts. The lack of crude purchases for the SPR is a significant blow to the oil demand picture. It will, if anything, put even more pressure on China to perform the heavy lifting on the demand side in the coming months.
Standing firm
Oil prices have fallen precipitously in recent months, with Brent and WTI falling to their lowest levels since December 2021 on fears of a fresh global banking crisis and an economic slump. Because of the pace and extent of the sell-off, many expect OPEC+ to interfere when it meets next month, especially because Brent has gone below $80/bbl, a price floor that many OPEC members unofficially support.
Despite the current price drop, OPEC is unwilling to intervene. During the sell-off, the oil cartel maintained a brave face, blaming the selling frenzy on speculative repositioning rather than any underlying malaise in the oil market. OPEC maintains its narrative of tighter oil fundamentals, buoyed by hopes of a rebound in Chinese economic and oil demand in the coming months.
Together with the threat of growing Chinese demand, Russia's supply is constrained. Last Monday, the sanctioned oil producer said that it will prolong its unilateral output limit of 500,000 barrels per day for another three months, until the end of June. Meanwhile, non-OPEC+ production growth this year is falling short of projections. OPEC's own supply increased marginally in February, but there is little room for additional production outside the organization. Most members are at or near capacity, and those that can pump more have shown little desire to do so.
Therefore, a decision to reduce output to support prices could be interpreted as a symptom of insufficient demand. Given this, OPEC and its non-OPEC allies are almost certain to maintain current production levels when they meet on April 3. In fact, the producer coalition is expected to maintain the current quotas through the end of 2023. Saudi Arabia's energy minister has stated that the producer group will maintain current production levels through the end of the year.
Inaction by OPEC, along with robust demand growth in China, should bring the oil market back into deficit starting in June 2023. According to the IEA's implied oil balances, demand will exceed supply by more than 1 million barrels per day between July and September, and by more than 1.5 million barrels per day from October through December. The anticipated supply deficit gives oil prices additional leeway to soar. Nevertheless, predictions are high that Brent will rise to $90/bbl as global demand reaches new highs while supply remains tight.
Nevertheless, oil prices are rising after a sharp drop amid optimism that the worst of the banking crisis has passed. Only time will tell if this rebound is sticky enough to last. What is obvious is that bulls expecting OPEC to decrease production to boost prices would be disappointed. The meeting next month should be a non-event as the oil cartel attempts to keep output stable for the rest of 2023. Ina will perform the most of the heavy lifting on the demand side in the coming months.
Backwardation
WTI, unlike its European cousin, is mired in contango. The front-month spread on the latter has been negative since November, while the corresponding spread on the former has been positive since the end of January. But that could change shortly. Notwithstanding the prolonged stagnant price malaise, the immediate WTI timespread has recently reduced. It is currently trading at roughly -12 cts/bbl, its highest level since the beginning of the year. While this is unquestionably a great step, more work is required to cause a permanent shift back towards backwardation.
Fortunately, this round of near-term structural strengthening appears to have legs to last. This is due to fundamentally supporting localised foundations. To begin, while US fuel demand remains below year-ago levels and the five-year average, it is well positioned to rebound during the summer months. The most recent macroeconomic indicators from the United States show increased economic activity and a strong labor market. This creates conditions that encourage gasoline use. Indeed, the EIA now anticipates that annual gasoline demand will increase this year.
Refinery runs are expected to increase as the American economy recovers and mobility improves. US refinery utilisation rates have been around 90% so far this year, but are expected to rise over this level in the third quarter as the turnaround season concludes and summer driving begins. This should result in a tightening supply backdrop, and it can't arrive fast enough. Following a multi-month rise, US crude inventories are ballooning. They are currently 16.4% higher than a year ago and 5% more than the five-year average. Nonetheless, a continuation of the decrease of US crude reserves is now expected. According to the EIA, US crude stocks will be 4% lower in the second half of this year than in the first. This will contribute significantly to WTI's rapid spread.
Continuing on the supply front, domestic production is another bullish factor for the WTI complex. From the beginning of the year, the country's crude oil output has been just above 12 million barrels per day. Nevertheless, American oil rigs have been declining since last month. All of this points to bleak growth prospects. The EIA reduced its forecast for US crude output this year in its most recent monthly report. In 2023, output is predicted to increase by 560,000 bpd, down from a previous prediction of +590,000 bpd. Nevertheless, it projected an exit rate of 12.5 mbpd this year, which is only 200,000 bpd higher than current production levels. The US crude patch's flattening producing profile bodes well for WTI's near-term backwardation goals.
Then there's WTI's secret weapon: strong overseas demand for American crude. Shipments had a banner year in 2022 and are off to a great start in 2023. According to EIA data, the latest four-week average is 4.7 mbpd, which is about 50% higher than the same period last year. Going ahead, given favorable arbitrage economics and lower Russian flows, US crude exports are well positioned to maintain their rising trend. In light of this, it would take a courageous man to bet against the US crude benchmark exhibiting significant structural increases in the coming weeks.
Place your bets
The oil markets saw one of the most volatile weeks in recent memory. Brent and WTI fell more than 10%, with prices reaching their lowest levels since December 2021. The price drop was fueled by bearish economic dynamics emanating from a global bank crisis. Despite the darkness, there was one bright spot: an increase in trading activity. According to exchange data, daily trading volumes on ICE Brent totaled 1.6 billion barrels last week. To put that in context, since the beginning of the year, average daily volumes on the European crude benchmark have been 951 million bbls. The trading frenzy peaked on March 15th, when 2.4 billion barrels were exchanged. A record 513 million barrels of Brent options were also exchanged throughout the day.
A rapid repositioning in speculative holdings was at the forefront of this flurry of trading activity. With concerns about the global financial sector and fears of a recession, money managers are relying again on declining oil prices. Each of these factors have reduced demand for riskier assets like oil. As a result, after rising since the end of last year, net speculative long on ICE brent has plummeted. Money managers reduced their bullish bets on ICE Brent crude by the equivalent of 65 million barrels during the most recent reporting period, which ended on March 7. This included a 50 million barrel decline in gross long positions and a 15 million barrel increase in gross short positions. Bets on rising Brent prices are already at an eight-week low. Furthermore, short traders have accumulated 37 million barrels worth $2.7 billion.
Oil markets are once again experiencing bearish sentiment. Yet, despite the latest reduction in bets on rising oil prices, the gross longs to shorts ratio remains at 7:1. This suggests that Brent prices will rise in the long run. Yet, speculation abounds over whether the surge into negative bets will continue. If the financial sector problem is contained and oil prices improve, some of the momentum should be lost. Even still, the threat of further Fed rate hikes might harm future oil demand and spark the next round of selling. The US Federal Reserve meets this week and is likely to raise interest rates by 25 basis points. Overall, the likelihood are that the speculative exodus from oil prices will continue.
Bears may be waking up early from their slumber, but oil bulls have ample reason not to give up. Energy forecasters are getting more bullish about the outlook for oil demand. This is due in major part to China's impending demand rebound, which has the ability to drive up oil prices. But, this is currently taking a back seat to the turbulence in the financial markets. Yet, the Chinese demand growth will soon take center stage on the oil market. Nonetheless, OPEC+ supply constraint and lower Russian oil shipments bode favorably for a price recovery. The underlying fundamentals will eventually tighten, hence the smart money is on a long-term price increase. But, anticipate oil bears to continue to dominate the market until then.