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Energy Markets Enter Peak 'Known' Unknown Season

Author: Brynne Kelly 8/15/2022

Reading through the headlines over the weekend, two main themes are constant. Both the supply and the demand sides are facing-off against large unknowns whose impact cannot be readily forecast. Opposing narratives in the press mirror market action as well. Those competing unknowns driving supply and demand fears of late are:

  1. Weather on the supply-side; and

  2. Gov't Policy influencing the demand-side.

These certainly are big unknowns this year. That's the bad news. But it is also the good news if you can believe it. Here's why.

While weather risks to supply are large unknowns this year, and government intervention is at historically high levels (price caps, Fed rate hikes etc); these are things we deal with every year. Sure, they are much bigger this time around; but as risk variables go, these are known-unknowns. Yes, we have big supply-side weather risk. We also have big government risk to demand. And yes, event risk is still out there, but at least the meetings are done, and what was the initial panic of war is now a chronic problem that can be better handicapped.

In short: We've been here before. It lines up like this:

  • Supply shortages vs Weather

  • Demand spikes vs Government Action

In both cases, we are approaching the peak Known-Unknown season. Meaning, the market has defined the problems that loom, but it's too soon to tell how they will play out. On the Supply-side: We know consumers are at risk this winter if Mother Nature delivers an unusually cold one, but we don't know if she will yet.

Meanwhile on the demand front, we know that high energy prices are having an inflationary impact on the economy and, as a result, governments are laying out measures to combat them to drive down demand But, we don't know how successful these policies will be yet either.

Let's look at the break down the two aggregated factors and how they may effect the behaviors of a couple key market participants

Supply vs Weather

The gloom and doom on the supply side is palpable and on display daily in media headlines like the following:

  • Britain's energy crisis will push millions into destitution this winter unless the government hands out more cash to help struggling households pay fuel bills, Rishi Sunak, the trailing candidate in the contest to become Britain's next leader, said.

  • The UK is the latest country to ready for blackouts and power shortages this winter, as Europe's energy crisis intensifies, according to a report

  • While Britain is not reliant on Russian gas to the extent that the rest of Europe is, “it is clear that the cessation of flows of gas into Europe could have knock-on impacts, including very high prices,” the ESO report said.

  • Paris Faces an Even Colder, Darker Winter Than Berlin

  • France’s Macron is appealing to the public to reduce their energy consumption. That’s the only way to prepare for the difficult winter ahead.

  • German residents make plans amid fears of a winter gas shortage

  • U.S. East Coast Diesel Supply Is Running on Fumes

The headlines are easy to swallow when looking at inventory balances, for example the combined US crude oil, gasoline and distillate inventories shown below.

Combined, oil, gasoline, and distillates are at historic lows going into the winter...

Low inventory creates a sense of inadequate supply as long as the market believes that storage holders' intentions are to 'stock up'. But, let's strip away the effect of US SPR draws from the chart above to see where commercial inventories stand. The picture looks less 'dire' as a result.

Energy inventories don't look as bad with SPR draws added back in...

Commercial inventories, in total, have managed to tread water and even to finally increase from the lows witnessed a few months ago. It appears as though the 'storage owner' that faces the most re-stocking pressure is in fact the US DOE at the moment. Since the DOE were in stockpile release mode prior to the covid/war/supply-chain crises anyway, it's also not a reach to think they won't be back as an inventory buyer in the foreseeable future. DOE resupply is a wild card.

But for the commercial players, restocking decisions have never been riskier given current price levels. Should they be patient as recession signals are debated and summer demand winds down?

Commercial players can wait to refill, but at risk to their operations...

How patient should one be ahead of the winter given the doomsday scenarios being played out in the media? Throw in the weather wild card these scenarios depend upon, and you have one of the riskiest buying decisions in a long while. It's a known unknown, but its a huge known unknown this year for them.

At this moment, it seems buyers have recession fears and the 'shoulder' demand season (aka, time) on their side. As a result, spreads have been collapsing, as traders are seemingly unwilling to over handicap projected supply shortages for now.

Calendar Spreads are finally signaling the supply crunch is abating...

Time is precisely what Commercials need right now. The time needed to get more clarity on how the spot market will respond to actual cold temperatures. Backwardation remains intact. In large part because historically low inventory levels provide little cushion for weather-related supply disruptions that exist as long as we are still in hurricane season.

The question remains whether they will get enough time though. That's one way to look at the Supply vs Weather unknown. Let's turn to the biggest factor affecting demand this year: outsized government involvement.

Demand vs Government Action

The government - through SPR releases - has certainly affected supply, even if only to move the oil from one account to another. But that is done as of September, it seems. There is little else western governments can do on the supply side of the equation right now. They have seemingly maxed out the SPR option. Hence, their focus must now be on the demand side. They have been using multiple policies to curb demand both broadly (raise rates) and narrowly (via rationing) to curtail use.

The main obstacle they had feared going into the winter season and a midterm election was high energy prices derailing economic growth. But now, they need a slowdown in demand. If they don't get it, they will have a bigger problem especially if the winter is cold. This fear is real as highlighted in a recent headline regarding utilities:

  • The only chance of survival for the utilities is to pass the huge jump in wholesale prices onto their customers. But that only moves the bailout down the chain, as households and businesses would then face unaffordable bills and need government help.

If they do not get demand down now to conserve what they have, they will be paying later. They may be paying subsidies to utilities, stimulus checks to consumers, or by losing votes at polls. If demand does not get lessened there can be a crisis. To the extent that they are successful in this manufactured demand-destruction endeavor is the big unknown on the demand side. We've seen this known-unknown before, but maybe never this urgent or this big.

As of the most recent EIA report, the demand for crude oil (as shown via crude oil input to refiners below) is within its 5-year range. First, demand seems normal so far but is that because of rate hikes or in-spite of them? More importantly perhaps is: the decrease in demand that has a tendency to drop-off significantly in the fall due to weather-related refinery outages or planned maintenance.

So far so good, but how will demand change as we enter maintenance?

This is of course what storage owners are counting on.

How much can Government Policy Change Demand?

Ahead of an expected event, government action/policy can change the slope of the demand line, but not its direction. In other words, the impact of high prices and supply shortages can be muted through subsidies, price caps, and forced demand reductions can lessen the demand slope. But these demand side government actions are not going to change the line's direction. Also: these measures merely 'kick the can' down the proverbial road.

Special Note: Subsidies seem to be in favor these days, almost expected. The problem with subsidies is they do little to change behavior, something that high prices are typically good at handling. By subsidizing demand, they actually increase price. This may be obvious at the retail consumption level, but it also has an effect at the utility level. One time increases in price caps for purchases is the same effect as subsidizing the utility. They are being given permission to pay up and will deal with the fall-out later.

On top of this, the Federal Reserve is currently dealing with the fact that we have full employment along with second quarter's gross domestic product shrinking. Some claim this 'has never happened before'. This only serves to increase the risk regarding future Federal Reserve action. The push/pull of forces attempting to predict the outcome is only fueling the uneasiness.

Regulatory risk is also huge right now. A winning strategy can be turned on it's head in an instant by regulations aimed at lowering prices. This, while most definitely government action and a known unknown, is more of an "event" risk. Declaring martial law or re-starting lockdowns for a disease would be examples of that. Emergencies are no longer unknown-unknowns after the last two years we've had.

Bottom Line

Some may be damned if they do, and damned if they don't...

  1. The unknown risks to this winter's operations are outsized compared to prior ones based on where we are coming from headed into it

  2. Most supply side issues are still large but at least known right now. The big exception is weather disruption risk

  3. Demand issues entail government attempts to lessen demand at the macro level (the Fed) and at the micro level ( caps, rationing etc)

  4. These two unknowns are much bigger in their potential effect than in past winter seasons, but are not completely foreign to us. We can deal with them if we are careful

Nevertheless, the combination of the situation we are in with the one we could end up being in from either of these risks have made risk management of price risk increasingly binary for professionals.

If you are a commercial player who is looking at levels to restock in an environment like this and have been around a while, you may be torn as to which risk to use for current guidance.

Do you remain patient and let the government orchestrated demand destruction do its thing via recession? Or do you just cover and hope to be able to pass some costs off without killing margins too much if we tank?

Either way, with these large off-setting factors at play, operators are likely feeling as if they are damned if they do hedge, and damned if they do not


EIA Inventory Recap - Week Ending 8/05/2022

Weekly Changes

The EIA reported a total petroleum inventory DRAW of (2.60) for the week ending August 5, 2022. Commercial inventories however, posted another weekly BUILD of 5.50.

YTD Changes

YTD total petroleum EIA inventory changes show a DRAW of 142.70 through the week ending August 5, 2022.

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 flounder while backwardation in the market persists. The real 'worrisome' figure is distillate inventory levels.


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