The Energy Report: Try to Hit the Oil Yield Curve

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prices got thrown an oil yield curve despite reports of better-than-expected demand and tighter-than-expected supplies. Oil traders in global markets continue to price in a global recession and based upon what we are seeing in the German yield curve and data this morning out of the Eurozone, they may get their wish.

Oh sure, US oil demand is at the highest level since December of 2022 and supplies of petroleum if you include the draining of the SPR are below the five-year average. Global supplies are below the 10-year average but the traders in the market are still suggesting that despite the fact the market will be oversupplied by the end of the year, they are going all in on the bet that the world will flip into a recession this year. The reason being they do not want to bet against global central banks that in some cases are pushing for a quick recession to stave off inflation that they feel is entrenched.

The move by the European Central Bank to raise interest rates by a more-than-expected quarter-percentage-point move to 3.5% was the ECB’s eighth consecutive interest rate hike and brought the rates to the highest level since 2001. That helped the German yield curve invert the most since 1992, a sign to some that they believe a recession is imminent. Now data overnight coming out of the Eurozone is showing that already things are slowing. The French PMI came in at 48 contractions as opposed to the expansion of 52 expected. The HCOB German Flash Composite Purchasing Managers’ Index (PMI), dropped to 50.8 in June from 53.9 in May, below analysts’ expectations for a reading of 53.5. That means oil markets have been confident enough to not worry about historically tight supply because they are sure central banks can crush the economy.

John Kemp at Reuters pointed out that, “In the physical market, dated prices are in contango through the rest of June and July, indicating traders expect plenty of crude to be available.” The reason they feel confident in that bet is they are confident that global central banks will do too much and cause a major slowdown in the economy and in oil demand and based on the plunging PMI data, the market is getting more confident it is right. It is a global recession or bust bet.

On the flip side as Mr. Kemp points out that, “Like many financial equilibria, this one may prove fragile. Global petroleum inventories are well below the long-term average, especially for refined fuels such as diesel and gas oil. If the global economy avoids recession and resumes steady growth, low inventories could quickly put explosive upward pressure on prices and spread.”

At the same time, all the recession talk and talk of more regulations on oil and gas from the Biden administration is causing US oil and gas producers to pause on investment. In fact, according to the Dallas Fed Survey, the business activity of oil and gas in Texas stalled to the lowest reported level since 2020. The Dallas Fed said, “Oil and production increased at a slower pace compared with the prior quarter, according to executives at exploration and production (E&P) firms. The oil production index was 8.0 in the second quarter versus 10.5 in the first. Meanwhile, the natural gas production index declined to 2.1 from 7.4.

Firms reported rising costs for a 10th consecutive quarter. While the indexes remain above series averages, the rate of cost increases slowed. Among oilfield services firms, the input cost index remained positive but fell sharply to 41.2 from 61.6. Among E&P firms, the finding and development costs index plummeted to 14.9 from 46.8. Additionally, the lease operating expenses index declined to 26.0 from 37.6. Oilfield services firms reported deterioration in most indicators. The equipment utilization index turned negative, falling to -7.9 in the second quarter from 3.9 in the first. The operating margin index tumbled to -21.6 from 1.9. The index of prices received for services remained positive but decreased to 3.9 from 25.0.

So, the optimistic predictions that US oil production would continue to break records might get challenged. Future tightening supplies just as Saudi Arabia cuts output by 1 million barrels a day on July 1 and the US finish its SPR releases. Yesterday the EIA reported US production fell back to 12 million barrels a day from 12.5 mb the week before.

The other factor that we must continue to watch is the grain markets for their potential impact on ethanol and other biofuels. US crop conditions for this time of year for corn are at the worst ratings since the 1988 drought and for soybeans the worst since the 1990’s. Yet there is hope as the GFS weather model is talking about the possibility of rain 10 days out. BAM Weather (BAMWX) reported yesterday that the GFS model trended substantially wetter in the 6–10-day period as an active flow pattern develops around the periphery of a ridge. Whether it’s right or wrong, it causes things to happen. We had said anything beyond day 7 cannot be trusted for the time being. BAM said, “We will run with that idea for now but keep this in the back of our mind because as we have said all along the pattern supports a change to wetter, we just have not been able to see it happen so far.”

BAM Weather also said, “Have had several questions and comparisons to other historically severe drought years. They have plotted May 1st to June 22nd, 1988, 2012 and 2023.  They said, “We are not as dry as we were in 88 but drier than 12 if you can believe that. The ONLY saving grace is we have been cooler than both years. The Morning European model had a decent rain in the eastern belt over the weekend…something our team is monitoring closely.”

On the flip side of that the carryover for grain is much lower, in fact almost a historic low compared to global demand, than in past drought years. Even though it has been cooler, dry hot wind is sucking the moisture out of the plants across big parts of the Mid-West.  

Mike Wagler of Rosedale Farms said it best when he said, “If substantial rains develop over the weekend this grain move might be over, yet if it does not develop, the move in grains has just begun. You better keep an eye on it by downloading the Fox Weather AP.”

DTN reported that RINs were higher, and ethanol cash prices were lower Thursday. July corn was down 10 1/2 cents at $6.60 1/2, while September closed 6 1/2 cents at $6.17. Overnight we are seeing further downside pressure on rain hopes. Not to mention the big grain report a week from today.

The EIA reported that U.S. crude oil refinery inputs averaged 16.5 million barrels per day during the week ending June 6, 2023, which was 116 thousand barrels per day less than the previous week’s average. Refineries operated at 93.1% of their operable capacity last week. Gasoline production decreased last week, averaging 9.8 million barrels per day. Distillate fuel production increased last week, averaging 5.1 million barrels per day.

U.S. crude oil imports averaged 6.2 million barrels per day last week, which decreased by 220 thousand barrels per day from the previous week. Over the past four weeks, crude oil imports averaged about 6.5 million barrels per day, 2.3% more the same four-week period last year. Total motor gasoline imports (including both finished gasoline and gasoline blending components) last week averaged 925 thousand barrels per day, and distillate fuel imports averaged 144 thousand barrels per day.

U.S. commercial crude oil inventories (excluding those in the Strategic Petroleum Reserve) decreased by 3.8 million barrels from the previous week. At 463.3 million barrels, U.S. crude oil inventories are approximately at the five-year average for this time of year. Total motor gasoline inventories increased by 0.5 million barrels from last week and are about 7% below the five-year average for this time of year. Finished gasoline inventories decreased while blending components inventories increased last week. Distillate fuel inventories increased by 0.4 million barrels last week and are about 14% below the five-year average for this time of year.

Total products demand over the last four-week period averaged 20.0 million barrels a day, up by 0.8% from the same period last year. Over the past four weeks, motor gasoline product supplied averaged 9.2 million barrels a day, up by 3.1% from the same period last year. Distillate fuel product supplied averaged 3.8 million barrels a day over the past four weeks, down by 0.6% from the same period last year. Jet fuel product supplied was up 3.1% compared with the same four-week period last year.

Natural gas stayed strong on the heat wave. The EIA reported that working gas in storage was 2,729 Bcf as of Friday, June 16, 2023, according to EIA estimates. This represents a net increase of 95 Bcf from the previous week. Stocks were 571 Bcf higher than last year at this time and 362 Bcf above the five-year average of 2,367 Bcf. At 2,729 Bcf, total working gas is within the five-year historical range.

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