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A Fearful Bullish Market....

Author: Brynne Kelly 10/31/2021

Crude oil prices continues to climb while threats of 'increased production' loom. Where this increased production would come from is largely theoretical at this point. Governments across the globe continue to suggest they have 'tools' in their arsenals that they can use to lower energy prices.

The upcoming week is highlighted by the 26th UN Climate Change Conference and an OPEC+ meeting which creates a backdrop of rainbows and kittens (aka, endless headlines).

On Sunday, US energy secretary Granholm indicated the US is still considering a release from the country’s strategic oil stockpile to be among the “tools” it could use to reduce prices. “I’ll let the president make that decision, make that announcement,” Granholm said.

The White House also stated (per a senior administration official) that it wants OPEC+ to boost oil production, AND ALSO that it’s discussing with allies 'what to do next' if the cartel doesn’t meet the request. U.S. President Joe Biden keeps the suspense on oil diplomacy, but he strongly signals Washington will counter. Asked how the U.S. would respond if OPEC+ governments don’t act, he said: “What we’re considering doing, that I’m reluctant to say before I have to do it”. Huh?

The next OPEC+ meeting is scheduled for Thursday, November 7.

Against this backdrop of rising energy prices, the UK began hosting the global climate summits - called COPs - which stands for ‘Conference of the Parties’ or (COP26) in Glasgow which is scheduled to run from October 31 – November 12, 2021. Per the COP26 website, countries are being asked to come forward with ambitious 2030 emissions reductions targets (NDCs) that align with reaching net zero by the middle of the century. To deliver on these stretching targets, countries will need to accelerate the phaseout of coal, encourage investment in renewables, curtail deforestation and speed up the switch to electric vehicles.

Given that, however, on Sunday initial statements from the leaders of the Group of 20 major economies seemed to fall short of expectations. What was said was that the group agreed on a final statement that urged "meaningful and effective" action to limit global warming, but offered few concrete commitments, angering climate activists. In addition, the United Nations and the European Union launched a global watchdog on Sunday to monitor governments' pledged reductions of greenhouse gas methane that have the potential to make a rapid contribution to limiting temperature rises.

U.S. President Joe Biden said on Sunday it was "not inconsistent" for him to push energy-producing nations to increase output of fossil fuels while also urging countries to commit to an energy transition.

Bottom line, it all seems like finger-pointing rhetoric. We are drowning in rumors of a rescue from higher prices looming just around the corner. As a result the market bias has skewed towards the upside with a careful eye on the 'future' - when supply side issues will be resolved. Basically, the market continues to front-load it's crisis bets.

This sentiment has rolled through the spread markets in oil. Nothing says front-loading like an explosive butterfly. In the example below, we use the Dec/Mar/Dec butterfly to highlight this phenomenon. This is the spread between the front 6 months and the back 6 months of the curve (Dec/June versus June/Dec).

The premium to own the front of the curve continues to grow. Currently, the front spread (Dec-21/Jun-22) is $4.00 OVER the back spread (Jun-22/Dec-22) which is the highest level recorded since at least 2013!

The relentless buying in energy markets has not only pulled oil markets into severe backwardation. It has also lifted the entire curve such that you have to go out as far as May-2024 to find a contract trading below the $60 level.

Many are questioning whether oil futures are reflecting the worst case scenario of supply shortages for the upcoming winter season, or if they are simply out over their skis.

What's confusing though is the decline in crack spreads of late.....if the world is so short of oil, why isn't that forward-presenting via product spreads (aka crack spreads)? After all, oil is merely the raw good used to produce consumer-facing products such as gasoline and heating oil. This Led market participants to question the aforementioned shortages in the market.

However, this decrease in crack spread values over the last week is largely driven by a decrease in RIN (Renewable Identification Number) values as shown below:

So, what is underpinning this move higher? Inventories and refiner throughput (refiner demand for crude oil).

Crude Oil Input to Refiners

Just as the lack of refiner demand for oil sent prices plummeting to record lows last year, the return of refiner demand lifted prices to new highs this year. At the moment, current prices and throughput resemble those not seen since 2014.

After all, since 2020 we have seen some major dips in refiner throughput from the pandemic and then from winter storm URI. Another severe storm this winter could certainly impede refiner production as it did last year and return crude back to storage.

However, with refined product inventories being on the low side, it would seem prudent to own refined products over oil should we see more refining issues.


Another tailwind behind higher prices is inventory levels, which we have been hearing a lot about lately. Indeed, both in total and at Cushing, US inventory levels are nearing levels not seen since 2014 (purple lines vs red lines in both charts below).

Last week's dip to below 30 million barrels marks the lowest level of Cushing crude inventories since the first week of October in 2018. Digging a little deeper into the data, we compare historical WTI spot prices to outright Cushing levels. Once again, we see the similarity to 2014 conditions. It's also worth noting how quickly Cushing stockpiles rose in 2015 from the lows of 2014. Back then, this was driven by a surge in US shale oil production.

What doesn't resemble 2014 is the amount of active rigs. The Baker Hughes rig count data for 2014 is almost 4 times current levels. 2014 and 2015 were years of extreme growth in US supply of crude oil. 2020 was a year of extreme contraction in the number of active rigs drilling for oil in the US due to plummeting demand followed by a return of demand faster than the return of supply. Still, U.S. energy firms added oil and natural gas rigs for a 15th month in row in October as oil prices soared to fresh seven-year highs.

Yet, we continue to hear narratives from the oil majors regarding their futures plans. Recently, the Exxon Mobil Corp board said it is debating whether to continue with several major oil and gas projects amid a global push from investors for fossil fuel companies to be more cost-conscious and green-energy friendly, WSJ reported on Wednesday.

With WTI 12-month calendar strips averaging at or above $60 through 2025, one wonders why this is still a debate. It's becoming clear that 'price' alone is no longer the motivating factor it once was. The great price collapse of 2020 has left participants with a bad taste in their mouth and climate aspirations are doing little to assuage that.

Absent the traditional signals we have seen when oil prices rally unchecked (like increased drilling activity, the addition of pipelines, etc.) oil markets have moved into severe backwardation. The production growth we saw during the US shale era seems a distant memory. Given today's environment, it's unlikely we will see another supply surge like that in the near future. Backwardation is now the baseline as far as the eye can see:

Supply-side additions in the near term are not pointed towards growth, rather towards OPEC+ production increases or releasing barrels from Strategic Petroleum Reserves. While either of these actions could dampen the level of backwardation in the short-term, the uncertain nature of actual supply growth still looms as a larger back-drop that won't be resolved any time soon. The conditions appear ripe for winter weather to drain resources further and result in even higher prices. Maybe then we will finally see a change in future production and the cycle can begin again. Until such time, short term bullish sentiment is vulnerable to headlines jawboning about supply and who 'should' provide it.

Of Note Over the Weekend:

  • Goldman Sachs: Anticipating US Federal Reserve to begin hiking interest rates in July 2022 (previous forecast Q3 2023).

  • OPEC+ intends to raise oil output by 400k BPD every month to ensure enough supply to markets - Kuna News

  • The ruling LDP of Japan won an overall majority in the election, according to the NHK.

  • Saudi Energy Minister Abdulaziz emphasizes the need of guaranteeing reasonable energy prices - Saudi Press Agency

  • The United States Department of Energy has announced a roughly $200 million investment to cut emissions from automobiles and trucks.


EIA Inventory Statistics Recap

Weekly Changes

The EIA reported a total petroleum inventory BUILD of 0.80 for the week ending October 22, 2021 (vs a net DRAW of 11.40 last week).

YTD Changes

Year-to-date cumulative changes in inventory for 2021 are DOWN by 137.30 million barrels (vs down 138.10 million last week).

Inventory Levels

Commercial Inventory levels of Crude Oil (ex-SPR) compared to prior years are have gone from way above historical levels to surprisingly below historical levels and should continue to draw as long as backwardation in the market persists.


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