The Energy Report: Old Time Economics

Give me that old-time economics, give me that old-time economics, give me that old-time economics, it’s good enough for me. Oil and product prices are starting to come to grips with a looming supply shortage. Now taking a risk of sounding like the old codger,  that I am , I would say it’s about time. Call me old-fashioned, if you will but I think that the market should reflect supply and demand and the risks to the same.

In years past, it seemed to me that the oil market had an uncanny ability to access supply and demand in the future. The market could take into accounts not only current supply and demand but future projections as well.

Yet since last April it seemed that the market divorced itself from supply and demand.

The market seemed to ignore the fact the global oil inventories when compared to record breaking demand that according to the International Energy Agency rose by 2 million barrels a day and is on a current on pace to hit 101.9 million barrels a day, are tightest, they have been in history.  Exxon Mobil (NYSE:XOM) said today that are already seeing record demand this year, but they expect it again record demand next year.

Now admittedly there were some real concerns about the risks to the global economy.  The market was trying to assess the impact of risng interest rates to levels many of your traders had never seen in their career.

The Federal Reserve announced Wednesday it had raised its key interest rate by 0.25% to as much as 5.5%, the highest level in 22 years and yesterday the European Central Bank (ECB) s rose to a record high last seen in late 2000. The bank raised the deposit rate in the 20-nation bloc for the ninth time in a row – to 3.75%, up from 3.5%.

We kept hearing about a disappointing reopening of the Chinese economy even as they imported near record amounts of oil adding to their oil reserves and running refineries at near record rates.

On July 13th, Reuters reported that China’s crude oil imports in June jumped 45.3% on the year to the second-highest monthly figure on record, customs data showed. Crude imports in June totaled 52.06 million metric tons, or 12.67 million barrels per day (bpd),  It was a substantial increase on the 8.72 million bpd imported in June last year.

Yet the real disconnect came because of a combination of a record amount of oil released from global strategic oil reserves as well as the banking issues and failures in the US and overseas.

Massive oil release distorted the markets and discovered oil investment. That made investors wait to invest but what really took away the oil markets predictive powers was multiple high-profile regional bank failures, The collapse of the Silicon Valley Bank (SVB), SBNY, and First Republic Bank and later the failure of Credit Suisse dried up liquidity from the petroleum markets. That allowed economic pessimism to reign supreme despite oil supply and demand evidence to the contrary.

Now somehow the market is shocked as gasoline crack and heating oil cracks stary dangerously close to all-time highs, Some seem surprised that gasoline prices hit a new eight-month high overnight of $3.732 according to triple A.

Sure, it was driven in part by hot weather, power outages and refinery issue but ther real problem is that demand has been exceed supply globally keeping gasoline supply near the lowest levels since 2015 while gasoline demand according to Valero is back to pre-covid levels.

In fact, according to Bloomberg Valero thinks that the Department of Energy Is underestimating gasoline demand. “ We’re seeing gasoline sales in our system, up 14% year-over-year, up 20% from pre-pandemic levels.”

The Department of Energy’s , Energy Information Administration (EIA) also added to the uncertainty with record adjustments to their crude oil supply number while the DOE does a great job normally with supply and demand those adjustments created more uncertainty and helps reduce liquidity in the futures market.

Or distillate stocks which are historically taught.

John Kemp at Reuters said last week “U.S. inventories of diesel and other distillate fuel oils have failed to replenish significantly despite a downturn in manufacturing and freight activity that has so far lasted eight months. Distillate fuel oil inventories amounted to just 118 million barrels on July 14, according to data from the U.S. Energy Information Administration (“Weekly petroleum status report”, EIA, July 19). Stocks were 21 million barrels (-15% or -1.15 standard deviations) below the prior 10-year seasonal average and the deficit had narrowed only modestly from 27 million barrels (-19% or -1.65 standard deviations) a year ago.

And now the question becomes what the Biden team can do about this price spike that they help cause with their push against fossil fuel investment and embracing ESG. The Biden team soured relations with Saudi Arbia with its “bull in a china-cabinet” foreign policy that was shortsighted especially because the relationship with Saudi Arbia is much larger than the dire to punish the whole country for Saudi Crown Prince Bin Salmans alleged murder of Jamal Khashoggi, a Saudi dissident journalist was assassinated by agents of the Saudi government at the Saudi consulate in Istanbul, Turkey

Yet today they are sending a high-level delegation to try to repair relations, in hopes they can get back on track the. Trump initiative to get Saudi Arbia to normalize relations with Israel.

Don’t think that the subject of oil won’t come up. President Biden’s adversarial relationship with Saudi Arabia started with his proclamation that he was going to make our longtime ally of pariah state. When Saudi Arabia failed to jump in raise production when President Biden called on the country to do so.

President Biden tried to retaliate by releasing oil from the strategic petroleum reserve. That move was doomed to fail.

Saudi Arabia encouraged the draining of the SPR by raising prices for their oil on the assumption that other countries would buy the oil and drain our reserve. The end game was to make  us more dependent on Saudi Arabia in the long run.

That move seems to have paid off as U.S. oil production is now falling because of lack of investment . We see that in falling rig counts that hopefully will stop failing soon.

Looking forward Saudi Arabia is now cutting production to try to get the market back in line with fundamentals at some point.

We may think Saudi Arabia is right to do so because the only way that we’re going to be able to meet demand in the future is to get prices high enough prices to encourage investment to offset the policies around the globe that discouraged oil and gas investment.

We a may need a price shock to get global leaders to wake up to the fact that there is net zero carbon goals are doomed to failure. The haphazard way that they’re throwing money at green energy sources before they can viably replace the amount of production that they are shutting down due to their policies.

But now it seems like the chickens are coming home to roost,

The risk of a growing supply deficit is becoming all too real to the market, We are starting to see that priced in with record crack spreads.  Is th e potential of a breakout to the upside for oil is $100 a barrel off the table? While a lot of things must happen, but the answer is absolutely not .

Natural gas continues to move sideways as conflicting pressures of strong production versus record-breaking demand based on power generation needs.  Z Mans Energy Brain is predicting that next week’s injection into supply is going to be a record low for this time of year.