Author: Brynne Kelly 12/04/2022
Headline risk has not been in short supply this year as the markets continue to digest war-time realities, supply shortages and Covid lock-down threats. Lately the focus has been on price levels and the measures different world leaders are taking to keep a lid on rising energy prices. Needless to say, most of this involved measures intended to shore-up supply in the face of reluctant producers.
All the while, market participants have stood by and watched the excessive inventory levels brought on by the Coronavirus pandemic disappear as a demand recovery took hold. One of the measures the US used to bridge the gap between economic recovery and slowing production was to release barrels from its Strategic Petroleum Reserves. The existence of this 'gap' has kept a bid under the oil markets all year. Coupled with uncertainty, you get volatility.
As this year comes to a close, and some of the more recent headline risk uncertainty has passed, oil markets seem to be settling in to a range.
WTI Spot and Calendar Strip Futures; Home on the Range again?
The price shocks earlier in the year have not been re-tested, regardless of the narrative. For sure the market remains hostage to weather and there continue to be undertones of 'winter shortages' that lie beneath the surface. But, the market is acting a bit more like "I'll believe it when I see it" lately as we mark uneventful time on the winter calendar.
UNKNOWN HEADLINE RISK BECOMES KNOWN
Last week's agenda had the market looking forward to a few events as catalysts to move narrative forward:
OPEC+ Meeting
G7 Price Cap Announcement
Potential Russia/Ukraine War Escalation
SPR Release extension possibility
Interesting that the above major events, war escalation risk aside, were all timed to roll off almost simultaneously by world leaders. Tinfoil hat notwithstanding - How have all these played out? It turns out, quite uneventfully actually!
OPEC+ MEETING HIGHLIGHTS (Sunday)
While many feared OPEC+ might increase production or deviate from their narrative, in fact OPEC and its allies decided Sunday to stick with their existing policy of curtailing oil output, maintaining the announced production cut of 2 million bpd which came into effect in November.
Not only did OPEC+ remain steadfast in their course of action, they cemented this by announcing that their next meeting isn't until June 4, 2023, which is quite a reversal from their hyper-sensitive monthly meetings to address market imbalances and Geopolitical rhetoric.
In their Sunday announcement, OPEC stated that:
"[I]ncluding the adjustment of the frequency of the monthly meetings to become every two months for the Joint Ministerial Monitoring Committee (JMMC) and the authority of the JMMC to hold additional meetings, or to request an OPEC and non-OPEC Ministerial Meeting at any time to address market developments if necessary."
Bottom line, OPEC+ changed nothing and went on to say that they aren't going to meet again for 6 months. As in 'we know what we are doing and aren't going to react to the situation on a granular level anymore.' So, just like that OPEC decided the open issues were resolved.
Maintaining the 2 million bpd level outcome was largely expected heading into the meeting after two weeks of intense speculation amid various media briefings from delegates ranging from a further output cut to even an increase in quotas. The abrupt slow down in meetings was not. Both signal volatility reduction for markets
G7 PRICE CAP CLARITY (Sunday)
The uncertainty surrounding whether or not the G7 would get its act together and agree on a price cap before the deadline for abolishing Russian oil purchases is now over. After all of the back an forth between member countries, we finally have an announcement of the agreement:
The Group of Seven price cap on Russian seaborne oil came into force on Monday as the West tries to limit Moscow's ability to finance its war in Ukraine, but Russia has said it will not abide by the measure even if it has to cut production.
And while this may seem a letdown, without this agreement Russian oil shipments would be stalled. So it is a step in the right direction as far as supply goes. As the agreement stands now, Russian oil can be shipped to third-party countries using G7 and EU tankers, insurance companies and credit institutions, only if the cargo is bought at or below the price cap (currently set at $60/bbl).
Reportedly, the cap goes into effect December 5th. While the risk of Russian retaliation remains, it has shrunk considerably given the time both sides had to square up their risks. it also helped that Oil prices subsided and weather was not an issue so far. That amounts to another event resolved with lower upside volatility perceived as an outcome.
The level of the cap is set to be reviewed by the EU and the G7 every two months, with the first such review in mid-January.
RUSSIA/UKRAINE WAR (Friday-Saturday)
This one, while technically not a scheduled event came about in a seemingly impromptu announcement by US intelligence. The US Intelligence chief, Avril Haines, predicted 'reduced tempo' in the war over the next few months, and waning morale of Russian forces entering winter.
The Director revealed the United States Intel community's current assessment that it expects the intensity of the Ukraine-Russia war to wane going into the winter months, only to ramp-up again during counteroffensives in the spring. "Once you get past the winter, the sort of question is: What will the counteroffensive look like?" Haines said before the Reagan Defense Forum in Simi Valley, California on Saturday. "We expect that, frankly, both militaries are going to be in a situation where they’re going to be looking to try to refit, resupply, in a sense, reconstitute, so that they’re kind of prepared for that counteroffensive."
WTI 12-Month Calendar Spreads Retreat...
As a result, the bellwether 12-month calendar spread in WTI is getting crushed as this could allow for inventories to replenish ahead of the next crisis move.
SPR RELEASES GOING FORWARD (Friday)
Last week, the US Energy Department announced they are looking to pause 'Mandatory" oil reserve sales. The Energy Department is seeking to cancel or delay sales mandated by Congress in fiscal years 2024 through 2027 so that it can move forward with a White House plan to refill the oil reserve if crude prices reach around $70 a barrel, an agency official told a Senate committee Thursday.
“It doesn’t make sense for us to be releasing oil while we’re trying to refill the SPR,” Doug MacIntyre, the department’s Deputy Director for the Office of Petroleum Reserves, said in testimony before the Energy and Natural Resources Committee. “We can’t fill and release from the same site at the same time.”
Such a plan, which would require congressional approval, could be attached to a must-pass government funding bill that could come together this month. The SPR, which has a capacity of around 700 million barrels, is currently at about 389 million barrels, according to Energy Department data.
Basically, large SPR drawdowns are coming to an end. The 'threat' of future releases is not off the table, but for now, the onslaught has ended.
And just like that, a potentially volatile event came to a definitive close for now. Not only are they not selling more. They are openly talking about buying some back. Less politically charged volatility risk is the potential result.
Where does this leave us?
The SPR announcement, while responsible for the nation long term, does leave us with a supply gap in the short term. That begs the question of how to make this shortfall up. Before we answer that one, let's look at the US Supply/Demand picture, one of the key drivers of this past year's price activity and certainly dependent in part on the SPR releases.
US SUPPLY DEMAND PICTURE
Real US supply in the form of production is non-existent as shown below. In fact, Net US oil supply (which includes production plus net imports) has been on the decline this year (black line below).
US Crude Oil Supply is Rolling Over...
Meanwhile, weekly US EIA refiner demand for crude oil (lime green line above/below) has almost recovered to pre-pandemic levels.
US Refiner Demand Flirting with Pre-Pandemic Levels...
THIS is the crux of the issue that remains. Where will future supply come from if the US is not growing it's own organically? Less important long term but pretty important right now, how will we cover the shortfall from the SPR drawdown stopping? Putting our tinfoil hats back on we find an answer.
SPR RELIEF? (Contracts signed Sunday)
Last week, Chevron won a six-month license that will allow them to run it's oil operations in Venezuela and sell the output. The path to bring Venezuelan oil to market has suddenly been 'cleared' as SPR drawdowns come to an end. Interesting.
Chevron is so far the only major Western oil company cleared by the U.S. to resume operations in a country possessing some of the world’s largest oil reserves. Investments in new assets are still prohibited. The U.S. says that renewal of Chevron’s six-month license is contingent on concrete progress in the negotiations, and that it is willing to revoke the license if it isn’t satisfied with the process.
Political jawboning aside, as long as both sides remain amenable to the deal, we would tend to expect this 6-month lease to evergreen.
So to recap the above, Three major events: OPEC's meeting, The G7 Price caps, and the SPR all resolved favorably within days of each other. What is more, the SPR cessation was counterbalanced with new supply coming from Venezuela. That other risk, or war uncertainty? Our intelligence agencies tell us expect a lull in the war for a few months. Interesting indeed. Time to check on market impact.
Market Impact
Unresolved issues that have led to market uncertainty are seemingly reaching predictable conclusions. Event Risk has been subdued and the oil curves are reflecting this slight 'win' with a move to contango in the front of the market.
Front of WTI Curve Continues to Show Relative Weakness
Beyond that, key calendar spreads have significantly pulled back from their highs.
12-Month Dec/Dec Calendar Spread Weakness
We now have a market that is looking for clues going forward paired with a lack of significant 'Event Risks' on the calendar.
WTI Prices Settle into a Range
Over the summer, the market paid up for 'supply security' amid a low inventory/high price environment. This is a market that has spent almost a decade enduring 'producer hedging' only to now face 'consumer hedging' by governments. In other words, this is not your typical consumer hedge (i.e. where airlines buy the curve in anticipation of higher prices in order to protect their bottom line). This new form of consumer hedging comes via governments securing new supply sources in order to avoid being flat footed this winter due to weather demands. This is a new 'layer' of hedge that isn't as apparent to the naked eye. It is one that is based on the belief that 'shit will hit the fan and someone better be ready for it' type of hedge that retail players aren't participating in. Meaning, retail players are not increasing inventory at these price levels.
Continuous WTI Prices Remain Elevated Historically...
Meanwhile, inventory levels remain low. Especially in refined products.
US Refined Product Inventories Remain Low Despite Supply Fears
This suggests that the inventory 'fundamental' is taking a back seat to short-term fundamentals. In fact, since oil, gasoline and distillate futures in Calendar 2023 broke their trendline this summer, they have been unable to recover.
Prices Continue Lower as Trendline Breaks...
So, why are prices coming off? Inventories are still historically low and so is production. Yet concerns have dropped markedly even if inventories do not warrant it. it is important to note that while the fundamentals have not been repealed, the market seems to be less concerned. Further, the last remaining known-unknowns (i.e. the events of this past week) all have resolved favorably going into the end of year holidays. It's a Christmas present for us. Perhaps more appropriately, a Hanukah miracle since they used oil lamps that never ran out?
Bottom Line
So, where does that leave us now? For one thing, it leaves us all a little fatigued after a year of supply/demand fundamentally driven markets that pivoted on event after event for months. Trying to look forward, with little scheduled in energy, and the supply/demand side known but currently ignored in pricing, one can bet on weather. That however is risky.
Every heat degree day we don't get in November and December is a heat day we can absorb with existing supply on the back end in February and March. So the weather remains a factor for sure, but absent any open unknowns after last week, the market may continue to ignore the supply-side issues we still have for now.
Something to think about
Fundamentals have driven these markets for over six months this year. Now it seems they may be taking a back seat to the more mechanical trading that inhabits Oil for periods.
CTAs are longer HO and RB than usual for this time of year according to some data trackers (TD, BOA, JPM) we watch. The HO part did not surprise us, given the season. But the RB did a little.
CTAs and Small funds: Too Short Oil, Too Long Products...
Given that participants have been closing OI for the past few weeks in Oil and other commodities, it stands to reason they may also be thinking of this in Products as well.
Historically, HO and RB are the darlings of the CTA retail set for their seasonal appeal. And historically, those same CTA participants tend to exacerbate moves in thinly traded markets when they decide to close their positions simultaneously.
While this is neither definitively bullish nor bearish in itself, it makes sense to watch cracks especially if WTI is stronger.
For example, if an orderly WTI move higher comes, and the cracks don't get as perky as they had been, it stands to reason CTAs and smaller funds are done allocating momentum strategies this year; Which would warn of more aggressive liquidation risk if WTI turned lower.
Distillate Cracks Continue to Lead...
We also know, retail has been bailed out by weather in the past and ended up making money. Therefore, as the year-end approaches we are happy just watching what the retail algorithm players do and gauging responses accordingly. It seems smart to play short term flows after such a tumultuous 6 months with only 20 days left on the board. This way we can keep bigger powder dry for 2023 while keeping the fatigue of a wild 2022 unwind at bay. Just something to think about.
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EIA Inventory Recap - Week Ending 12/04/2022
Weekly Changes
The EIA reported a total petroleum inventory DRAW of 7.70 for the week ending November 25, 2022. Of this, Commercial inventories posted a weekly DRAW of 12.60 while SPR inventories DREW by 1.40.
YTD Changes
YTD total petroleum EIA inventory changes show a DRAW of (236.50) through the week ending November 25, 2022. The bulk of this is due to drawdowns in SPR inventories.
Inventory Levels
Both Distillate and Gasoline inventory levels remain decidedly below their 5-year average for this time of year.
