The Energy Report: Policy Driven

Oil prices and product prices have rocketed back, not so much on the fact that demand is strong and supplies are tight, even though they are, but because of policies by governments that are really behind these big petroleum oil price moves. It’s clear that the plunge in oil price going into and especially after the Memorial Day holiday had little to do with supply and demand, but rather about concerns whether or not the US would default on their debt. As that prospect became less likely, oil came roaring back. In fact, a surge in oil this morning came on another potential policy move by the government. A report that China, where supposedly the market had oil demand concerns even as they imported and refined record amounts of oil, said they are considering a property support package to boost the Chinese economy.

Property bubbles is a major concern for the Chinese economy as the government encouraged the real estate sector to get overbuilt. That raised concerns of credit and reality that their housing crisis could derail  after covid economic recovery.  After it appeared that China would stimulate and bail out the sector, the US dollar index fell giving oil and other commodities a boost.

The dollar is getting even more support with growing expectations that the Federal Reserve will pause their interest rate hikes in June. It makes sense that the Federal Reserve would take a pause especially after the turmoil in the regional banking sector. Another rate hike may cause more banks that are ‘on the bubble’ to fail. It also makes sense that the Fed started to assess the impact from their previous historically fast interest rate increases to make sure that they’re doing more damage than good. We will get the monthly jobs report and one of the interesting things that we’ve been seeing from other employment indicators is that the jobs market continues to be holding up quite well. On the other side of the economy, we’re seeing weakness in the industrial sector which is raising concerns about a broader slowdown in the future as well as reports of tightening credit conditions from banks.  The manufacturing PMI slipped from its flash 48.5 level to 48.4 final in May, down from 50.2 in April (the 6th month below 50 of the last 7) and that should be a concern.

The recent drop in commodity prices and oil prices have been exasperated by fears of Fed interest rate hikes and other macroeconomic policies that could lead to a recession. The reality is the Fed risks making some inflation more permanent if they stay in this aggressive rate hiking cycle. The rate hikes could make the structural shortage in commodities and the supply chain worse. In other words, the Feds aggressive action could discourage investment in oil and gas production as well as other commodities creating a structural shortage that would keep inflationary pressures high for the long term. The Federal Reserve’s blunt instrument of raising interest rates can’t drill an oil well, plant a wheat field, nor can it operate a factory. Yet it could stop those who do because they cannot get or afford credit.

In the meantime, back in the US petroleum supplies ranch, inventories are below the average range in supply in every major category. Even After the Energy Information Administration reported a 4.5-million-barrel increase in crude supply, {{8849|U.S. crcrude oil inventories are 2% below the five-year average for this time of year. It is even worse than that if you consider that strategic petroleum reserve supplies fell by 2.5 million barrels and are at the lowest level since September of 1983. Products did not fare much better as total motor gasoline inventories decreased by 0.2 million barrels from last week and are about 8% below the five-year average and distillate fuel inventories increased by 1.0 million barrels last week and are about 18% below the five-year average for this time of year.

Why do they keep telling us demand is bad but again demand is for total petroleum products at a four-week average of 20.0 million barrels a day, which is up 2.3% from the same period last year. Gasoline demand averaged 9.2 million barrels a day, up by 3.5% from the same period last year. Distillate fuel demand product supplied averaged 3.9 million barrels a day over the past four weeks, up by 1.2% from the same period last year. Jet fuel product supply was up 3.0% compared with the same four-week period last year.

Now if OPEC holds a meeting and no reporters are invited will anyone hear it? This inventory story creates a dilemma for OPEC plus. Based on supply and demand data, OPEC should be getting ready to increase production to meet demand. Yet prices will force them perhaps into a potential production cut. At the very least it is expected that the group will solidify and make official the ‘voluntary’ production cuts.

Myra P. Saefong at MarketWatch reports that, ”A meeting by major oil producers on Sunday will lack the element of surprise, two months after an unexpected decision to implement deeper production cuts led to a temporary rally in U.S. prices to their highest level of the year. June 4 marks the first official OPEC+ meeting since December, and it comes at a time of heightened tensions between Saudi Arabia and Russia, among the world’s largest oil producers.”

I agree with Myra, that that’s the common thinking. Yet as we learned at the last meeting OPEC may actually want to give the market a surprise. Not only the fact that there are some reporters not being invited to the meeting, but also because they’re meeting in person. Also because of the warning from Saudi Energy Minister Prince Salman’s to speculators.

That could mean there’s going to be the potential for heavy negotiations as to future policy. The drama that people want to see is the relationship between Saudi Arabia and Russia after reports that the two were at odds over Russia’s perceived lack of compliance to production cuts. Will Saudi Arabia lose their patience with Russia. The surprise scenarios will be if Saudi Arabia and Russia decide to engineer a production cut and shake the short speculators out of the market. The flip side is will the tensions between Saudi Arabia and Russia lead to another price war which could cause a major sell off in the price of oil even though a production war may be needed to meet demand in the second-half of the year and the years to come. If I had to put odds on it, I would say there is a 55% chance of no change. A 44% chance of a production cut, and a 1% chance of a production war.

Michael Lynch at Forbes is also looking for a cut. He said that, “A new quota cut seems likely to be announced this weekend, probably about 1 mb/d which will translate into an actual reduction of perhaps 400 tb/d, mostly from Saudi Arabia. The bulk of the members will shrug it off, but the UAE +0.4% and Russia will likely resist, de facto if not verbally. Given current (and likely near-term) demand for oil from OPEC+, that should not cause a major price move, but will put a floor on prices and nudge Brent back up towards $80, at least in the short term.”

But will Russia cut. The market has been dismayed by Russian compliance and mixed messages from Russian Deputy Prime Minister Alexander Novak who said he expected no new steps from the OPEC+ group of oil producers at its meeting. Yet before we get too much into that remember his boss, Russian President Vladimir Putin said that oil production cuts were required to maintain a certain price level, contradicting assurances from other leaders of the OPEC+ group of producers that it was not seeking to manage the market in that way. In other words, it’s about price and not supply and demand. So, if the Saudi’s offer up a cut, do not expect Russia to stand in the way. Also expect Russia to promise better compliance.

Natural gas had a setback after a bearish report from the EIA after two weeks of bullish reports. Reuters reported that natural gas inventories increased by +110 billion cubic feet to 2,446 billion over the seven days ending on May 26. Stocks were +280 billion cubic feet (+13% or +0.67 standard deviations) above the prior ten-year seasonal average up from a surplus of +217 billion (+13% or +0.47 standard deviations) at the start of the refill season on April 1.