In crisis, there can be opportunity, and good can come out of bad. While the drop in petroleum prices was predicated on the fear surrounding the global banking crisis, it did provide an opportunity for users of petroleum. Users and producers of oil and petroleum products are starting to understand that this recent crash in oil products has been overdone. While banks and hedge funds, and speculators flee, there are signs that hedgers, as we recommended, are stepping in.
Bloomberg News reported that Swap dealers posted their second-biggest increase in long positions in ICE (NYSE:ICE) Brent futures and options on record last week. The 54,000-contract surge was previously eclipsed only in 2018. Bloomberg pointed out that swap dealer positioning is often used as a proxy for producer and consumer hedging activity because it offers a glimpse into where entities dealing in over-the-counter transactions, such as banks, lay off risk into futures markets.
As I wrote before, the oil sell-off was based on more fear of contagion in the banking sector than any real supply or demand fundamentals with oil. Consumers such as airlines and big oil users are starting to realize that the sell-off in oil and products based on supply and demand didn’t make sense. This was about the risk-off positioning, as many hedge funds had to de-risk.
While the market was trying to grasp just how bad the failure of Silicon Valley bank and the sale of Credit Suisse UBS would have on the overall market, we might find out that it could turn out to be more bullish for the market. The reason is that the banking cracks that have been seen will force global central banks to slow their interest rate increase, which should allow oil demand to continue unfettered.
Weirdly the cracks in the global banking system may turn out to be bullish for oil because the Federal Reserve will have to be a lot less aggressive in trying to talk down oil prices because they realize that they could unleash more problems with the global banking system. Add that to the fact that inflation expectations have come down dramatically.
Dr. Ilia Bouchouev, the former President of Koch Global Partners, tweeted,
“Hedge fund sold 1.5x more barrels just in 2 weeks than the record SPR did in the entire year."
The problem is when funds buy back their shorts; there will be no SPR to offset the buying pressure. This comes on more signs that China's oil demand is coming back in a big way. Oil watcher Tim Dallinger pointed out that flights in China rose to 978,182, a whopping 291% from a year ago and just shy of the all-time high.
Bank lending for oil production may also slow, the FT reported yesterday, “The fall in prices has been a wake-up call,” said Matt Bernstein, an analyst at Rystad Energy. Top publicly listed shale producers have locked in prices for only about 27 percent of their output for 2023 at an average of approximately $66 a barrel, down from the more than 40 percent of output they hedged last year, according to data from Rystad.
Some of the largest US producers, including Pioneer Natural Resources (NYSE:PXD), EOG Resources (NYSE:EOG), and ConocoPhillips (NYSE:COP), have little to no price hedges in place for this year. Scott Sheffield, chief executive of Pioneer, defended the positions, saying the recent dip in crude markets “had nothing to do with the lack of oil demand” and that he was still “optimistic that we’ll see $100 a barrel before the end of the year”. “We’re not going to hedge,” he said in an interview.
Supply issues are going to come into play. French strikes are reducing supplies of refined products. Iraqi federal government and Kurdish officials disagreed on the resumption of around 400,000 barrels a day of oil exports from a Turkish port, according to people familiar with the matter, as reported by Bloomberg.
We’re hearing from the Russian energy minister who says they expect oil and gas production to decline in Russia this year. Reuters reported that Russia’s energy minister said the country had successfully re-directed its oil exports to new markets but that oil and gas production would decline in 2023. Russia’s Deputy Prime Minister Novak said that Russia should seek to produce at least 100 million tons of liquefied natural gas per year by 2030.
Biden’s foreign policy is bringing people closer together, especially our enemies. China’s President Xi Jinping spent three days in Russia, solidifying his “no limits” partnership with Russian President Vladimir Putin. On Tuesday, Joe Biden kicks off his second Summit for Democracy — aiming to rally world leaders around principles of freedom, rule of law, and human rights, according to Politico.
Reuters is reporting that the governments of Iran and Saudi Arabia — rival Islamist states that recently agreed, under the auspices of China, to restore their diplomatic relations — announced on Monday that their foreign ministers would schedule a meeting during the Muslim holy month of Ramadan.
So the bottom line is that the outlook for oil and products is still very bullish, assuming that we do not see any more fallout from the banking crisis with the plot by the Fed being less aggressive. We believe that we’re in the perfect environment where we will see demand exceed supply.
Natural gas bulls need a shoulder to cry on. The shoulder season is putting pressure on the natural gas market. This was one of the most promising markets a year ago, but warmer-than-normal temperatures and the closing of the Freeport LNG terminal changed the fundamentals.
Longer term, if you look at the time spreads, natural gas could see higher prices in the future, but right now, that doesn’t help you if you’re on the front end of the curve. If you are on the back end of the curve, it is thin, and there is not any option liquidity to help you hedge.