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Brace For Impact

Author: Brynne Kelly 10/10/2021

Lackluster inventory reports threatened to weigh down oil prices early last week but by Friday oil had rebounded towards 5-year highs. The market continues to be laser-focused on global supply issues, specifically that for coal and natural gas for electric power generation. As a result, oil markets are bracing for impact - physically and mentally preparing for something that is imminent, in an attempt to limit any adverse impact. Impact, in this case being higher energy prices.

Over the last several years, futures prices have managed to stay within a fairly routine distribution around the $55 level. This year, we have seen prices on either side of the frequency distribution. January 2022 futures began the year around $47 and settled last Friday at just around $78. Both data points are outliers on the distribution, however $78 much more so than $47. Things can get noisy at low frequency price levels.

After US inventories were released on Wednesday, it seemed as though oil markets had reached momentary saturation on bullish sentiment. Then on Friday, Shell announced that it was ready to begin the process of restarting units across Norco, Louisiana site. It stated that the first units will begin the start-up process and subsequent units will follow over the next several weeks at Norco, Louisiana site on October 9. Suddenly, the front month futures spread in WTI went from a slow coast lower during the fund roll, to a rally that caught market participants off guard (Nov-21/Dec-21 spread = gold line below).

Despite the return of demand and on-going fears of future production deficits, front-month expiration in WTI has been a bit of a disappointment this year, succumbing to the pressures of the fund roll every month (blue, teal and lime green lines above). The Nov-21/Dec-21 spread was headed down such a path at the beginning of last week (gold line above) but did an about face by weeks' end. In typical WTI fashion, a rally in the front spread filtered throughout the curve and pushed consecutive month spreads to new heights with the Dec-21/Jan-22 calendar spread now the crown jewel (seafoam green line above) of impact sentiment.

We saw a similar pattern in distillate spreads. After a brief bit of weakness early last week, distillate spreads closed out the week on fresh highs (left chart below).

The front of the market is deemed the most vulnerable to supply/demand imbalances and it shows. The 12-month Dec-21/Dec-22 calendar spreads in US gasoline, distillate and crude oil finished out the week at all-time contract highs.

It's worth noting that all of this is happening while we are technically in a shoulder month. That time of year when demand for crude oil slumps due to refiner maintenance and prior to the winter surge in heating demand. As noted many times before, we are in the peak 'unknown, unknown' season. A time when fears of winter weather are at their peak and knowledge of how this all plays out is scarce to come by. Over the next several weeks, the market enters a delicate dance between incredibly bullish sentiment and seasonally low oil demand. This seasonal slowdown in demand can be see via the weekly US EIA crude oil input to refiners.

Trying to take a cue from historical fourth quarter inventory changes over the last 6 years reveals a bit of a mixed bag; 3 years posted increases in total crude oil inventory in the 4th quarter and 3 posted decreases during the 4th quarter (chart below). Considering where inventories stand today versus prior years, a further decrease in oil inventories from here could become problematic.

Last week we noted: "The circumstances in China and European natural gas and coal markets are certainly having an impact on US markets. But the conditions driving them aren't necessarily the same." The continuing narrative surrounds coal supply for electric generation. That narrative has flooded the market with bullish sentiment and has provided the fuel necessary to push oil markets towards upside levels not even fathomable less than a year ago!

However, coal and natural gas futures lost ground last week against oils shift higher across the curve (gold line below = Brent).

Yet, for all the talk about coal and LNG prices, oil has held it's own this year. On a heat content adjusted basis, the spread between US WTI Crude Oil and US Henry Hub Natural Gas has actually widened over 67 percent this year (gold line vs red line below).

Clearly global market conditions are reflected much more in oil prices than they are in local US natural gas prices. Oil is much more easily storable and transportable than natural gas and has more forms in which it can participate in energy shortages in other parts of the world.

Bracing For Impact - Global Conditions


China’s energy shortage is due to a severe demand-supply imbalance: surging industrial output as the world economy recovers from the impact of the COVID pandemic, at a time when output of the coal it needs to fire electric-power plants is failing to keep up with needs and arid weather in the south has crimped hydropower.


Most of Lebanon was left without power Saturday after the country's two main power plants ran out of fuel, government officials said. Officials were working "to partially restore electricity to various Lebanese regions, by supplying production stations with fuel from the reserves available for extreme necessities," state-run NNA news reported, according to CNN. "Electricity will gradually return in the coming hours." Al Jazeera said angry residents protested at electricity provider Electricite du Liban in Akkar province and blocked roads in Tripoli. "There is no fuel and limited generation, so the variation in frequency is ruining the grid," Marc Ayoub, an energy researcher at the American University of Beirut, told Al Jazeera. "It's happened about 16 times over the past two weeks because generation is too little compared to what is needed for the grid to reach stability." Lebanese Minister of Energy and Water Walid Fayyad said the fuel shortage is related to financing from the World Bank. Lebanese President Michel Aoun warned the country was headed for a total power blackout, which could occur by the end of the month, due to dwindling fuel reserves.


Just like Chinese authorities ordering energy firms to conserve supplies at all costs, numerous power plants across India could be forced to adopt rolling blackouts as coal supplies run low. A minister in Indian capital New Delhi warned Sunday that blackouts could rock the massive city over the next two days. But the nation's capital city isn't alone in suffering energy shortages: it joins two Indian states - Tamil Nadu and Odisha - which have issued warnings about the growing possibility of blackouts due to dwindling coal supplies.


Asia’s spot liquefied natural gas (LNG) prices exceeded this week the psychological threshold of $50 per million British thermal units (MMBtu). The $56.326/MMBtu price of the Platts benchmark Japan Korea Marker (JKM) for November was an all-time high at which a cargo of LNG traded in the Asian market, and was more than $20/MMBtu higher than the previous record of $34.52/MMBtu, set just last week. Rallying LNG prices have already seen a massive 870-percent surge since the low for 2021 at $5.80/MMBtu at the end of February, Reuters columnist Clyde Russell notes.


Europe, meanwhile, is suffering a perfect storm: A cold 2020-21 winter caused inventories of natural gas to fall, just as new supplies delivered by pipeline from Russia and Norway were disrupted. Imported liquefied natural gas could have filled the gap, except that energy-hungry Asia is aggressively competing for supplies. The same goes for coal, whose global price has soared amid Chinese demand.

As stated earlier, energy markets are in the peak of "Unknown unknown' season. Any one of the above conditions could be the catalyst for explosive upside moves or they could turn out to be a prelude to nothing. Time will tell.....

Of Note Over the Weekend:

  • Southwest Cancels 27% Of Flights, Blaming Controllers And Storms - BBG

  • UK Pilot Shortage Threatens Travel Rebound And Airlines - Telegraph

  • Goldman Cuts US Growth Forecasts For 2021 And 2022 - BBG

  • Statement by the Oil and Gas Union in Libya on Sunday: We hold Prime Minister Dbaiba fully responsible for not meeting the demands of the workers, and therefore the only option we have is to reduce production and close the ports. We demand the activation of the government's decision no. 642 of 2013 on increasing the salaries of workers in the oil sector. We condemn Dbaiba’s statements in which he referred to activating the decisions issued in 2017 on some ministries without referring to us.


EIA Inventory Statistics Recap

Weekly Changes

The EIA reported a total petroleum inventory BUILD of 4.40 for the week ending October 1, 2021 (vs a net BUILD of 4.30 last week).

YTD Changes

Year-to-date cumulative changes in inventory for 2021 are DOWN by 112.90 million barrels (vs down 134.30 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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