Specious Argument

My expectation for September’s West Texas Intermediate (WTI) oil prices has changed. WTI should range from $70 to $90 per barrel. A narrower range is from $72.50 to $82.50 per barrel. The wider range has shifted downward by $5 per barrel. And the narrower range has also shifted down.

This past month has been eventful. After the monthly employment report where job growth was softer than expected, markets reacted by dropping a few percent and increasing volatility. Some option traders got hurt because of the increased volatility.

And then almost as fast as markets reacted to the downside, markets recovered with more market data that suggested the economy was not cooling as quickly as feared and employment was still at reasonable levels. Furthermore, according to the CME Fed Watch Tool, rates are expected to drop either 25 or 50 basis points at the next Fed meeting in mid-September. A basis point is one-hundredth of a percent. Nonetheless, many believe that the US economy is slowing.

September and October are typically shoulder months for oil demand. The summer driving season is over, and the winter heating season has yet to arrive. Furthermore, OPEC+ has discussed reducing its voluntary cuts.

John Kemp from Reuters wrote an insightful article “OPEC+ faces moment of truth on planned output increase.”

LONDON, Aug 22 (Reuters) – In the next few weeks, Saudi Arabia and its OPEC+ allies must take a delicate decision about whether to proceed with planned production increases from October, or postpone them because of an uncertain economic outlook.

The recent slides in front-month Brent futures prices, calendar spreads and refinery margins, amid concerns about the outlook for petroleum consumption, have dramatized the danger of getting it wrong.

Boosting production despite downward revisions to consumption growth and a continued output increases from rivals in the United States, Canada, Brazil and Guyana risks another accumulation of inventories and slump in prices.

In addition to his commentary, Kemp provides several graphs with his article.

Amena Bakr provided helpful commentary in a thread on X where she commented about OPEC+’s compliance.

Thread: Let's discuss the new compensation schedule announced by Iraq and Kazakhstan. This move signals the group's unwavering commitment to the Opec+ pact. But this time, there's more to the story that suggests….’this time should be different’… Here's why: #OOTT #Opec

— Amena Bakr (@Amena__Bakr) August 23, 2024

Gary Ross also pointed out that some members, notably UAE, have been overproducing:

Amena does great work! But I must point out both have maintenance in 4Q so they r not really dedicated to comply. The elephant in the room is the UAE who has been way overproducing. While they too have maintenance in 4Q there is no way they can make up for huge overproduction https://t.co/OE1rBQPu3f

— Dr. Gary N. Ross (@kingofcrude) August 24, 2024

The New York Times reported in its article “In a Region on Edge, Israel and Hezbollah Launch Major Attacks on Each Other” (subscription required) that both sides were deescalating, at least for now.

Amid fears of an all-out war between Israel and Hezbollah forces in Lebanon, the two sides on Sunday mounted the biggest round of cross-border strikes since the war in Gaza began, with Israel bombing dozens of sites in a pre-emptive attack, and Hezbollah launching hundreds of rockets and drones.

Within hours, both sides appeared to de-escalate, at least temporarily, but signaled that the violence and dangerous tensions could continue. Hezbollah said its operation, vengeance for the Israeli assassination of a senior commander, had “finished for the day,” but left open the possibility of further action. Prime Minister Benjamin Netanyahu of Israel said that “what happened today is not the final word.”

For weeks, Israelis have waited in trepidation for a major attack promised by Hezbollah in retaliation for the airstrike last month in a suburb of Beirut that killed one of its leaders, Fuad Shukr. Iran, which backs both Hezbollah and Hamas, has also vowed retribution for the killing of Ismail Haniyeh, the Hamas political leader, on a visit to Tehran, hours after Mr. Shukr was killed, though it appears to have put that plan on hold.

While some believe the upcoming US election may be influencing prices, I am not among them. And once the election is over, I am not even certain how oil will react to a victory of either party.

As we can see, there are a lot of uncertainties, which are always true, and a lot of crosscurrents. My logic in lowering my price expectations is that the world seems adequately supplied with oil, oil prices did not spike in the latter part of summer as some suggested, and the oil market is entering into its shoulder season. I expect OPEC+ to moderate or delay its unwinding of voluntary cuts if Brent prices remain in the $70s per barrel.

My expectations for next month’s West Texas Intermediate (WTI) oil prices have changed slightly. WTI should range from $75 to $95 per barrel. A narrower range is from $76.50 to $86.50 per barrel, which has shifted a dollar per barrel lower than last month’s range. On Friday, July 26, WTI finished the day at near $76.50. This is the fifth month in a row where my expectation for my wider range has been unchanged, and the narrower range has changed slightly to reflect current prices.

There have been no fundamental changes to warrant changing my ranges. Although prices have fallen slightly from last month, prices have not changed significantly.

For those interested in a more bullish outlook, I encourage you to watch Energy Aspect’s podcast with Amrita Sen and Jeff Currie recorded earlier this month when Brent was hovering around $86 per barrel; Brent finished last Friday just below $80 per barrel. Currie suggests that Brent may hit $100 per barrel before the end of summer.

Last month, I discussed that oil and gas equities were lagging. Now, although oil prices have fallen, most oil and gas equities have risen. During the past several weeks, there has been an epic rotation in stocks. The Wall Street Journal published an article “A Stock-Market Rotation of Historic Proportions Is Taking Shape” (subscription required), where it discusses the unusual stock movements.

Few investors saw the shift coming, and many are puzzled by what is behind it: Changing forecasts for Federal Reserve interest-rate cuts? Expectations that Donald Trump will return to the White House? A technology trade that grew precariously crowded?

President Biden’s announcement Sunday that he wouldn’t seek re-election augmented the uncertainty and promised to refocus market attention on the presidential campaign.

Now, investors are scrambling to determine whether the reordering of winners and losers is a mere blip in an era of tech ascendancy—or if a sustainable shift is in fact under way.

This rotation is responsible for oil equities’ odd stock price movement, not Canada’s capital gains tax change. As I stated last month, Canada’s tax change would have zero influence on US oil equities.

When OPEC+ meets in early August, the market may learn new information regarding how OPEC+ intends to navigate the current supply and demand environment.

As seen from the closing WTI price on Friday and my narrower range, I expect that WTI prices are at or near their lower boundary. Of course, no one knows for sure. Commodity prices tend to have minds of their own. It seems to me, however, that WTI oil prices seem to be range bound between the high $70s and mid $80s. My expectations over the past few months have remained relatively constant.

My expectation for West Texas Intermediate (WTI) oil prices for July is unchanged from June. That is, WTI should range from $75 to $95 per barrel. A narrower range is from $77.50 to $87.50 per barrel. This is the fourth month in a row where my expectations have been unchanged.

On Friday, June 21, WTI finished the day at about $80.50. A month ago on May 20, WTI traded for about $79.50, a dollar less per barrel. Yet many oil equities were trading about 5 to 10 percent higher.

Several Canadian oil and gas investors on X (formerly Twitter) attributed this fall in value to the upcoming June 25 deadline for increased capital gains taxes. Canadian taxpayers who have more than CA$250k (about US$182k) in capital gains will have their inclusion rate increased from one-half to two-thirds. In other words, two-thirds of capital gains in excess of CA$250K will be taxed. For further information, please see the Canadian government document “Fair and Predictable Capital Gains Taxation.”

This tax rate increased created an incentive for Canadians to sell their oil and gas holdings that have increased substantially from the lows during the COVID period. The question is whether this taxation selling is the primary cause for oil equities residing at lower values today than a month ago. I will show that the answer is no, the lower oil equity valuations are not attributable to the capital gains tax increase.

Please note that I will use US, as opposed to Canadian, stock prices and will use adjusted stock prices that compensate for stock splits and dividends.

Looking at the correlation table below, we see that correlations are strong for all pairs of oil equities. The equities are Chevron, Canadian Natural Resources, Devon, MEG Energy, Suncor, and Exxon.

Table 1: Linear Correlation Table

The highest correlation is between CNQ and SU at 0.959. This result is not surprising because both are large, integrated Canadian oil sands producers.

Below is a scatterplot of CNQ versus SU.

Figure 1: Scatterplot of CNQ vs SU

The lowest correlation is between MEGEF and XOM at 0.825, which is still high. This result is expected because MEGEF is a midcap oil sands company producing bitumen, and Exxon is a large integrated company.

Figure 2: Scatterplot of MEGEF vs XOM

The correlation between MEGEF and DVN, Canadian and American midcaps, is higher at 0.912.

Figure 3: Scatterplot of MEGEF vs DVN

And finally, the correlation between two large integrated companies CNQ, Canadian, and XOM, American, is 0.877.

Figure 4: Scatterplot of CNQ vs XOM

The correlations between any two of these six companies are high, regardless of whether the companies are American, Canadian, or a mixture. While Canadian investors might have some influence on Canadian companies, they will have negligible influence on large-cap American companies.

If smaller Canadian retail investors wanted to reset their cost basis, they could have sold and immediately repurchased their shares. If a larger Canadian investor with a large number of shares wanted to sell and repurchase her shares, she could have engaged in a combination trade. Let us walk through an example. Say an investor has 100,000 shares of CNQ, which closed at US$34.48 that she wanted to sell and repurchase for nearly the same price. Dumping 100k shares on the market immediately would likely affect the stock price. So as last Friday came to a close, she could have executed the following combination trade, where both parts are executed simultaneously, for a credit of $34.93:

• Sell 100,000 shares of CNQ
• Sell 1,000 CNQ put contracts for June 21 with a $35 strike

Selling the 100k shares is understandable. When the investor sells 1,000 June 35 puts, she provides the counterparty or market makers with the right, but not the obligation, to sell 100k shares of CNQ at $35. The credit of $34.93 provides the market maker with a $0.07 per share incentive to execute the trade. Typically, the market maker will likely require $0.05 to $0.10 per share to execute the trade. The net effect for our imaginary investor is that she gave up $0.07 per share to sell and repurchase her shares on Friday.

If she entered the trade earlier in the day and wanted to ensure that the puts would be in-the-money at the trading close, she could have chosen the $36.25 strike instead of the $35 strike. In that case, the credit would be $36.18, again just $0.07 per share less than the strike price.

As far as the increase in Canadian capital gains taxes are concerned, they were not a major contributing factor in driving oil equity valuations lower. The correlations between any two oil equities in table 1 are high. Furthermore, Canadian investors could have easily sold and repurchased their shares through put assignments during the last several weeks and months. The reason for oil equities trading lower with oil prices at current levels remains a mystery.

Away from Canadian capital gains taxes and back to the original topic of oil prices, there have been no fundamental changes that have caused a reevaluation of my WTI range. While there were announcements by OPEC+, IEA, and EIA during the early June, nothing has fundamentally changed. So my outlook stays the same.

Disclosure: long and short CNQ puts; long and short DVN calls and puts; long SU stock, and long and short SU calls and puts; and long and short XOM calls and puts.

My expectation for West Texas Intermediate (WTI) oil prices for June is unchanged from May. That is, WTI should range from $75 to $95 per barrel. A narrower range is from $77.50 to $87.50 per barrel. This is the third month in a row where my expectations have been unchanged.

As I compose this blog entry, WTI is hovering around $77.25 per barrel, which is slightly below my narrower range. I expect WTI prices to strengthen in June.
Over the past month, nothing material has changed. Concerns about China’s recovery and growth remain. The wars in the Middle East and in Ukraine also remain. The US central bank is still worried about inflation.

A couple of months ago when oil was higher, many of the oil cognoscenti were suggesting that OPEC+, when it meets in the next few days, may need to add more oil into the market. According to a Reuters new article on May 31 “OPEC+ working on complex production cut deal for 2024-2025, sources say,” some are now suggesting that a deeper cut cannot be ruled out:

LONDON, May 31 (Reuters) – OPEC+ is working on a complex deal to be agreed at its meeting on Sunday that will allow the group to extend some of its deep oil production cuts into 2025, three sources familiar with OPEC+ discussions said on Thursday.

OPEC+ has made a series of cuts since late 2022 amid rising output from the United States and other non-members, and worries over the demand outlook as major economies grapple with high interest rates to tame inflation.

…

“We would not entirely rule out a plot twist – in the form of a deeper cut – given (Saudi energy minister) Prince Abdulaziz’s (bin Salman) penchant for Hollywood twist endings,” said Helima Croft from RBC Capital Markets.

A May 31 Bloomberg article “Key Oil Ministers Head to Riyadh as OPEC+ Plans Change Again” (subscription required, though the article can be found from other free sources) stated that the cuts will be extended to yearend and possibly into 2025:

Major OPEC+ producers will gather in Riyadh this weekend to debate oil output cuts after the Saudi-led group revised its meeting plans for a second time.

Top officials from Kazakhstan, Russia, the United Arab Emirates and Kuwait are among those due to convene in the Saudi capital on Sunday, according to officials. They’ll discuss prolonging supply curbs to the end of this year — and potentially into 2025, said delegates, asking not to be named because the information was private.

My own personal view is that the cuts will be maintained to at least yearend with more emphasis on compliance with the voluntary cuts. As the northern hemisphere moves further into summer with the driving season in full swing, oil prices will strengthen.