Oil prices are coming back on a general risk-on day, yet pulled back on a report that Russia’s oil output was rising. Oil traders may not want to stay short over the Juneteenth holiday may, but they may want to prepare for a potential energy backlash from Russia after the European Commission this morning made a recommendation to move forward with the EU ‘candidate status’ for Ukraine. This comes after China and Russia are working more closely together on an energy pact as China voices its support for Russia and refuses to condemn the war in Ukraine. Russia is still laughing all the way to the bank and oil squashed its overnight rally after Argus Media reported that Russian crude output will yet to rise in July to close in on levels attained before the war in Ukraine, citing Russian deputy prime minister Alexander Novak.
Oil seemed to bottom yesterday on a move by the Biden administration putting sanctions on a group of Iranian petrochemical producers and front companies in China and the United Arab Emirates. In other words, for the first time since Joe Biden has been in office, they are going to seriously enforce Iranian sanctions. That is after spending most of their time turning a blind eye to Iran’s skirting sanctions. Yet, this might be their last desperate attempt to save the flawed and dangerous Joint Comprehensive Plan of Action (JCPOA) nuclear deal that would allow Iran a path to a nuclear weapon in the future and failed to ban missiles that could deliver those weapons.
So, while oil has pulled back and we may consolidate, the supply-side fundamentals are still wildly bullish. This week the International Energy Agency (IEA) predicted that the world would see record demand. The IEA expects crude demand to reach 101.6 million bpd in 2023 and warns that global oil supply may struggle to catch up with demand. Yes, the same agency that was predicting peak demand a few years ago. Yet, because of the massive move to defund oil and gas projects, the target is being championed by U.S. Treasury Secretary Janet Yellen that we may not be able to meet demand unless prices soar much high to slow demand.
Recession fears are one reason oil is weak, but what would a recession do for demand?
While the recession may cool off prices in the short term because of the lack of energy investment upstream and downstream, we will continue to see a very tight market. And any dip in oil price may be short lived.
To get an idea of what may be coming, we look to past recessions. For example, the biggest demand destruction event in the history of the oil market was the worldwide shut down because of the coronavirus. According to the Energy Information Administration, global demand dropped by an unprecedented 9.3%. No one expects demand to drop like that even if we get a deep recession.
The next biggest demand drop was the 1980 recession, when demand dropped by 4.12%. If we get a similar bad recession, a 4.12%-drop in demand in a world that is expected to be consuming 101 million barrels a day, would be a substantial drop of 4.1 million barrels of oil a day. Right now in rough numbers, we are under-supplied by about 2 million barrels a day and a deep recession would put us in a rough surplus of above 2 million barrels a day. Getting the world, with very little spare capacity, a 2-million-barrel-a-day bump, is not that much oil. So in other words, even if we get a deep recession, the markets are going to remain in a vulnerable situation. Obviously, if everything goes smoothly, a 2-million-barrel surplus would allow the world to start to replenish inventories, but that is not a very comforting margin.
Things are even more supportive if the recession isn’t very deep. Data from the Energy Information Administration shows that the recession in 1981 caused a demand drop of 3.08%, and the recession in 1982 caused a drop of 2.69%. If you go back further, we had a demand drop of 1.42% in 2009 and we had a drop of less than 1% in that recession at 0.97 in 1975, we had a demand drop of 0.83%.
The great recession in 2008, believe it or not, only saw a drop of 0.6% in demand. That is pretty incredible because the price of oil in 2008 went from $147 a barrel down to $30. That price drop, of course, may not have been not just about demand but the fact that people were running away from a weak dollar due to the financial bubble. In 1983, we saw an oil demand drop of 0.24%, while in 1993, the slowdown was 0.22%.
While many people believe that we are in a recession and the Federal Reserve may even allow a small recession to try to cool off inflation, the reality is that the market fundamentals are still bullish. We have to be careful because we could see some price drops, but unless the economy goes into a total meltdown, those drops in prices should be opportunities to put on long-term bullish positions. There will be more and more interest in the back end of the oil curve at those prices. There are still discounts to the front, and that might be the area to look if we get a big drop in prices.
Yippee! The national average gas prices have fallen back to just $5 a gallon! Maybe the Biden administration should put out a press release taking credit for it! As we noted before the drop in our RBOB futures and increase in gasoline production in a dip in demand have cooled off prices. Yet, as John Kemp at Reuters points out, “U.S. gasoline prices at the retail level and adjusted for wages are now at the highest since 2013. Wage-adjusted gasoline prices are in the 94th percentile for all months since 1994, up from the 60th percentile at the end of 2021. At this level, demand destruction should be evident within the next few months."
So what to do? Blame Putin? Well, his production is going up. OPEC Secretary General HE Mohammad Sanusi Barkindo called out the U.S. for not raising oil production. Barkindo says the the low-hanging fruit in spare global production capacity is U.S. shale. He seems to be insinuating that it is the Biden administration’s fault for the globe being undersupplied because he has helped slow shale production. Biden did that by restricting pipelines, imposing drilling moratoriums and creating more red tape for project approvals. For the global undersupply of oil, I have to say the OPEC secretary-general makes a very persuasive case.
Discussions around capping gasoline and diesel exports have picked up in recent days, as Joe Biden intensified his criticism of soaring oil company profits. Limits under consideration would fall short of a complete ban on foreign sales of petroleum products, with gasoline exports averaging 755,000 barrels a day so far this year, according to the U.S. Energy Information Administration. That’s up from 681,000 barrels a day during the same period in 2021.
Natural gas had a wild ride yesterday, as Russia cut off supplies to Germany to support prices along with hot weather. The Energy Information Administration inventory report was also supportive. The EIA said: “Natural gas spot prices fell at all major locations this week (Wednesday, June 8, to Wednesday, June 15). The Henry Hub spot price fell from $9.46 per million British thermal units (MMBtu) last Wednesday to $7.72/MMBtu yesterday. International natural gas spot prices were mixed this report week."
Bloomberg Finance reports that the weekly average swap prices for liquefied natural gas (LNG) cargoes in East Asia fell 68 cents, to a weekly average of $23.09/MMBtu. At the Title Transfer Facility (TTF) in the Netherlands, the day-ahead price rose $3.21 to a weekly average of $27.70/MMBtu. In the same week last year (week ending June 16, 2021), the prices in East Asia and at TTF were $10.92/MMBtu and $10.01/MMBtu, respectively.
Futures: The price of the July 2022 NYMEX contract decreased $1.279, from $8.699/MMBtu last Wednesday to $7.420/MMBtu yesterday. The price of the 12-month strip averaging July 2022 through June 2023 futures contracts declined from $0.943 to $6.954/MMBtu.
Storage: The net injections to working gas totalled 92 billion cubic feet (Bcf) for the week ending June 10. Working natural gas stocks totalled 2,095 Bcf, which is 14% lower than the year-ago level and 13% lower than the five-year (2017–2021) average for this week.