Crude Oil Bottom Line – West Texas Intermediate reached another seven-year high this week, settling at $83.76. Bullish sentiment continued this week after stocks at Cushing, Oklahoma, dwindled even further.
Oil at Cushing now stands at just 31 MMBbl, near the lowest seasonal level in the past five years. It is unusual for inventories to decline this time of year, when refineries typically are still conducting scheduled maintenance. But the U.S. Midwest is being drained of oil. Stockpiles at Cushing have declined more than 4 MMBbl over the past two weeks. According to Bloomberg, traders generally believe that below 20 MMBbl, it becomes difficult to maintain normal supply operations at Cushing. It’s a bullish flag for WTI, but also a bearish one for the Midland differential.
Looking globally, Saudi Arabia implied no more oil would flow than planned, saying any extra oil from OPEC+ would do little to tame surging natural gas prices in Europe and Asia. OPEC+ is apparently staying the course with a conservative approach to adding oil supply.
The scarcity of barrels has supported prices, but also led to more backwardation in the forward curve. Backwardation in the oil market has reached extreme levels and can make hedging further down the curve less appealing. However, even Cal 2024 is trading above $63/Bbl, a level at which many of our clients say they are profitable. Want to mitigate the backwardation “penalty?” Costless collars can be an alternative to a swap here if hedges need to be added in Cal 2022 and beyond. The natural put-skew in the market that is usually present in oil options is not as punishing at the moment. This warrants a hard look at using collars instead of swaps.
Gas-to-Oil Switching. (Bullish, Surprise) The global shortfall in natural gas could have a bullish impact on crude if companies are forced to switch to oil for power generation. This is most likely outside the US, particularly in Asia and Europe, where natural gas prices near $40/MMBtu make it more economical to burn petroleum products. According to OPEC analysis, gas-to-oil switching could account for up to 300 MBbl/d in additional demand. Goldman Sachs paints an even more bullish picture, saying the actual number could be closer to 650 MBbl/d.
Trend. (Neutral, Surprise) Price trends tend to persist, which is why traders often refer to “momentum” or “inertia” in prices. Crude has been in an uptrend for seven weeks now. The November '21 contract has risen $6.29 over the past two weeks, with $2.82 of the gains coming over the last five trading sessions (October 15).
USD. (Slightly Bearish, Neutral) The U.S. dollar's value increased in September. Fed Chairman Jerome Powell provided hawkish guidance that the Fed will soon begin winding down the emergency economic stimulus program and potentially raise rates to cool inflation worries. A hawkish Fed may strengthen the dollar, and a stronger dollar may pressure crude prices lower.
Demand Recovery. (Bullish, Priced In) Demand has recovered strongly from the pandemic lows, and the U.S. inches closer to pre-pandemic consumption each week. The Delta variant had temporarily made the pace of demand growth uncertain, but the market seems to be optimistic, consistent with the recent run-up in price. Outbreaks in countries with low vaccination rates have caused some analysts to hold a more pessimistic outlook toward the global demand recovery. However, it is noteworthy that OPEC increased its outlook for demand in 2022 in its latest Oil Market Report.
Iran. (Bearish, Surprise) The U.S. and Iran have been holding indirect talks through most of the year to revive the JCPOA (nuclear) agreement voided by the Trump administration. A temporary atomic-monitoring pact used as a stopgap measure to allow for broader negotiations expired on Thursday, June 24, and talks have been stagnant since. Iran has pressed forward with its nuclear program and moved further out of compliance with the JCPOA. Most analysts' commentaries suggest that a deal is not likely until mid-2022.
COVID-19. (Bearish, Priced In) We reduced this factor's size as the market seems to have lessening concern of the impact of Covid on oil demand. Fuel demand has proved resilient in China, and the U.S., despite rising coronavirus infections. If lockdowns are re-imposed, it could weigh further on prices, but at this time, renewed restrictions of the full-lockdown style of 2020 seem highly unlikely.
U.S. Production. (Bearish, Surprise) So far, operating-rig data show U.S. private producers have responded to the increase in prices. However, many analysts say that significant U.S. production growth is unlikely without the help of public companies. But, prices above $55 through 2024 may be enough to draw capital from the sidelines.
Non-OPEC Production. (Bearish, Surprise) Many prominent research groups (EIA, IEA, OPEC) think non-OPEC production, dominated by the U.S., will increase in 2022. If these forecasts come to fruition, then it would have a bearish impact on oil prices if the market is otherwise well supplied.
OPEC+ Quotas. (Bullish, Priced In) Under the current deal, OPEC+ had an estimated 5.8 MMBbl/d of supply on the sidelines as of July 2021. The group plans to bring approximately 400 MBbl/d of additional production into the market each month through next fall; however, the additional supply has had little negative impact on prices.
Product S&Ds. (Bullish, Mildly Priced In) Vaccination rollouts in the U.S. and around the globe continue to gain traction. More bullish crude product demand recovery estimates are trickling in every day, as new data hints at a strong recovery. If the pace of the demand recovery continues, then crude demand could reach pre-pandemic levels much quicker than anticipated.
The supply and demand balance for most refined products has been very strong, explaining the high crack spreads and product prices. We have this factor as bullish and slightly priced in.
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