Specious Argument

I am reducing my West Texas Intermediate oil price range by $10 to range between $80 to $100 per barrel for October.

A few days after my last forecast, the price fell through the floor. Russia’s war on Ukraine intensified, the Fed’s seeming determination to raise rates regardless of whether higher rates cause a recession, and Prime Minister Truss’s chaotic mini-budget sent markets reeling. As I write, the VIX is nearly 32, an unusually high value. The VIX is often referred to as a fear gauge because the higher it is, the more volatile markets are.

The reasons for my forecast are as follows: Oil prices are likely to rise from recent lows in the $70s as we approach the end of the SPR releases at the end of October. I expect OPEC+ to announce a cut in production of between five hundred thousand to one million barrels per day at its upcoming meeting in early October. Prices should rise as the September and October shoulder season passes and winter approaches. Russian production may begin to decline. And China may begin to open after its once-in-five-years congress in mid-October.

Given the extreme market volatility, there are certainly risks. The US dollar may keep rising until something breaks. The mini-budget problems in the UK may spiral out of control and affect financial markets around the world. Investors may become so risk averse that nothing rises, including oil. OPEC+, because of all the economic uncertainty, may decide not to cut. China may clamp down even tighter to control COVID-19. And major world economies may slide into a deeper recession than many forecast.

Regarding OPEC+, I believe that it will cut its production because it prefers oil price stability instead of wildly gyrating prices and it wants to encourage more energy development, both oil and gas as well as renewables.

As the VIX indicates, market volatility is very high because of a lot of uncertainty. It is impossible to be confident of any particular outcome. The scenario I where described prices rising because of OPEC+ cuts, passing of the shoulder season, potential Russian production declines, and increased China demand, however, is the one in which I have most confidence. In general, I am bullish on oil prices going higher into the end of the year.

I am keeping my West Texas intermediate Oil price range of $90 to $110 per barrel for September. There are lots of crosscurrents that could move prices beyond this range.

Without any regard to likelihood or severity, the following developments may dramatically affect oil prices: Iran negotiations, violence in Iraq, Saudi Arabia and OPEC+ making a dramatic shift in production, developments that may affect Russian oil exports, a weakening global economy, hurricanes in the Gulf of Mexico, and miscellaneous others. Let us look at a few of these items.

Negotiations have heated up once again with Iran. Although the participants are providing different signals, I tend to disregard most comments because even the participants themselves cannot predict how negotiations will unfold. Often negotiations follow an uncertain and unpredictable path. So it is best to wait and see.

Extreme violence has broken out in Iraq. The Wall Street Journal article “Violence Erupts in Baghdad After Iraqi Cleric Moqtada al-Sadr Quits Politics” (subscription required) on August 29, 2022, states the following:

BAGHDAD—Violent clashes gripped Iraq’s capital after an influential cleric said he was quitting politics, as protesters stormed government buildings and heavily armed militias flooded into the capital’s government center, setting off an intense urban battle that threatened the government’s stability.

At least 17 people were killed by gunfire and more than 90 were reported wounded in clashes in the Green Zone on Monday, turning the heavily fortified district of government offices, embassies and villas of senior Iraqi officials into a besieged zone.

The unrest was triggered when cleric Moqtada al-Sadr made his declaration. His supporters, who had been camped for nearly a month outside Parliament demanding new elections, overran the nearby government palace, setting off clashes with security forces.

At this point, I am uncertain if this development will affect Iraq’s oil production and exports.

On August 23, 2022, the Wall Street Journal article “Saudis, Allies Open Door to Oil-Output Cut to Keep Prices High” seemed to indicate that Saudi Arabia was frustrated by the low oil prices in light of a tight physical market.

The Saudi-led Organization of the Petroleum Exporting Countries and a coalition of producers led by Russia—collectively known as OPEC+—agreed to a smaller-than-expected production increase earlier in August.

Now, Saudi Arabia’s energy minister and some OPEC officials have suggested the alliance could extract fewer barrels of oil to stabilize a market buffeted by economic uncertainty, the risk of global recession and energy sanctions triggered by the war in Ukraine.

“OPEC+ has the commitment, the flexibility, and the means…to deal with such challenges and provide guidance including cutting production at any time and in different forms,” Saudi Energy Minister Prince Abdulaziz bin Salman said late Monday.

Oil traders and pundits will be watching what OPEC+ decides over the long weekend and how Saudi Arabia positions its oil selling prices.

Russian oil exports have proved more resilient than many expected. Whether Russian can continue its success remains to be seen.

With energy prices rising sharply in Europe, some expect that Europe’s recession may be sharper and may last longer than expected. Whether the recession is severe enough to curtail substantial demands for oil remains to be seen. My intuitive guess is that oil will be largely unaffected because some electrical producers are switching from gas to oil.

Hurricane season is beginning to heat up. The National Oceanic and Atmospheric Administration still expects an above normal hurricane season. Hurricanes can knock out production from the Gulf of Mexico and may affect refineries along the Gulf Coast. The frequency and severity of hurricanes remain a wildcard.

These are the bulk of the factors that I am watching, but there are some others too. For example, watch the strength of the US dollar and its effect upon other countries, especially poorer countries, and their abilities to service their US dominated debts.

The course that OPEC+ decides to follow and the Iranian negotiations are my primary focus. But that could change in heartbeat. If Iraq is unable to sustain its oil production or problems in the Gulf are more severe than expected, then I will switch my priorities.

To summarize: I expect oil prices to range between $90 and $110 per barrel for September.

Just like last month, I am again lowering my West Texas Oil (WTI) forecast for the upcoming month by ten dollars per barrel to range between $90 to $110. While the physical market remains tight, oil may be held in check by the approaching shoulder season and recessionary fears.

A recent article on July 20 in the Wall Street Journal “Saudi Arabia Nears Its Oil Pumping Limit” (subscription required) demonstrates that the oil markets are tight and that there is a lack of surplus capacity.

Saudi Arabia has limited additional capacity to ramp up oil production, according to people familiar with its pumping ability, a constraint that would make it difficult for Riyadh to increase global supply even if it were willing to do so.

President Biden recently wrapped up a high-profile trip to Saudi Arabia, saying he expected the kingdom to help the U.S. boost global supplies. The Organization of the Petroleum Exporting Countries, with Riyadh as its de facto leader, meets early next month to determine whether to lift its current quota for production. The group has been working in recent years with a parallel group of big producers headed by Russia.

If OPEC+, as the two groups are called collectively, moves to boost production, a key question is by how much. Saudi Arabia’s slim spare capacity—the amount it can quickly ramp up on top of what it is already pumping—raises the prospect that any boost won’t be enough to appreciably lower prices.

During June and July, oil seemed to be unusually volatile, having risen to about $120 per barrel, then fallen to about $90, and it is now near $100 again. The stock market was also very volatile during this period. Although stocks had a terrific July, many are cautious or even skeptical about the months ahead. A quote from a recent July 29 Wall Street Journal article “U.S. Stocks Rise, Giving S&P 500 Best Month Since 2020” (subscription required) shows the gains for the S&P 500 and Nasdaq and concerns about the market going forward.

The S&P 500 gained 9.1% in July, while the Dow Jones Industrial Average rose 6.7%, the strongest monthly showing for each index since November 2020. The tech-heavy Nasdaq Composite climbed 12% for its best month since April 2020.

Investors have taken comfort in recent days from the idea that slowing economic growth might encourage the Fed to raise rates at a slower clip. They also have been encouraged by positive signals during earnings season, as expectations for quarterly profit growth rose over the past month.

But money managers and strategists are also debating whether stocks can hold on to the recent gains in the face of continued monetary tightening and worrisome signals about the economy. Many are skeptical.

Because of the strong cross currents of tight physical oil markets and recessionary fears, along with a war in Europe, it is hard to have much confidence in any forecast. Everyone is watching to see if strong recession indicators appear and how that might affect oil.

My July forecast for West Texas Intermediate (WTI) is that it will range between $100 to $120 per barrel, and this range is ten dollars lower than my June forecast.

When higher than expected inflation numbers, at over 8 percent, were announced in June, the market immediately expected the Fed would raise rates by 0.75 percent, which it did. The Fed seems committed to fighting inflation by raising rates and, thereby, increasing the odds of a recession, although the depth and length of the recession remain uncertain. Investors are fearful about the effects of a recession on oil prices, and consequently oil prices and oil equities fell in sympathy.

Many investors, however, remain bullish because worldwide inventories continue to decline. Even assuming a normal recession, many expect that the physical market for oil will continue to tighten. Eric Nuttall, from Ninepoint Partners, recently provided a worthwhile podcast and webinar with Amrita Sen from Energy Aspects. I highly encourage you to listen to the podcast and watch the webinar.

Even at WTI prices of about $110 per barrel, consumers are facing high gasoline prices because refinery crack spreads are extraordinarily high because of a lack of refining capacity. A refinery crack spread is the difference between revenue and costs for the physical outputs and inputs. A simplistic way to determine the crack spread is to use the 3:2:1 ratio of oil, gasoline, and distillate. Three barrels of WTI oil produce two barrels of gasoline and one barrel of distillate or heavy oil. Toward the end of the day on June 27, WTI was about $110 per barrel, RBOB gasoline futures were about $3.75 per gallon, and heavy oil futures, or distillate, were about $4.15 per gallon. Converting gallons to barrels and working through the math, the crack spread is about $53.10 per barrel. Crack spreads typically range between three dollars and $10 per barrel. For consumers, the gasoline prices at the pump are equivalent to about $153 (=110+53-10) WTI prices.

For more information on crack spreads, I encourage you to visit the EIA website.

As already stated, crack spreads are high because of a lack of refining capacity. Companies are loathe to build new refineries in North America because of the strenuous regulatory and environmental hurdles and because of the expected transition away from fossil fuels. Please view CNBC’s interview with Exxon’s Darren Woods. Most of the additional capacity in recent years comes from refinery creep, where existing refineries make modifications that allow for lower costs, higher throughput, or some combination.

Are there downside risks to my forecast? Yes, of course. If investors increase their expectations for a severe recession, then oil may sell off. Next, the Iran negotiations, known as the JCPOA, have shown more signs of life again. There were some meetings and calls made late last week. If a deal is struck in the near future, I am not sure how much that may influence oil. Some believe that the effects would be negligible because Iran is already exporting a lot. Other factors include a resurgence of COVID in China, a faster and harder economic slowdown, and some development with Russia that enables it to increase production.

Risks to the upside include continued oil inventory withdrawals with the physical markets tightening even further, resumption of the Chinese economy to normal activity, and Russia’s exports declining significantly.

Regarding recession concerns, the Wall Street Journal article “Consumer Sentiment at Record Low Is Another Ominous Sign for Economy” illustrates consumers’ concerns.

Consumer sentiment fell to its lowest point on record, reflecting that elevated inflation is weighing on Americans’ moods and adding to indicators that point to a slowing in the world’s largest economy.

The University of Michigan’s gauge of consumer sentiment reached a final reading of 50 in June. That was the lowest reading on record going back to 1952, and down from both an initial reading earlier in the month and May’s 58.4 reading.

New-home sales rose 10.7% in May to a seasonally adjusted annual rate of 696,000, separate data Friday from the Commerce Department showed. Economists, however, expect rising mortgage rates to weigh on sales later this year.

Similarly in Canada, as reported by the CBC in its article “Canadians are dispirited, cutting back on costs amid inflation highs: study,” consumers are also feeling the burden of higher inflation.

With inflation at a 39-year high—and banks hiking interest rates to avoid economic recession—many Canadians are said to be distressed and dispirited as they cut back to manage the rising cost of living.

A new study from the polling non-profit Angus Reid Institute shows that 45 per cent of Canadians believe they are worse off now than they were at this time last year. Inflation is now at 7.7 per cent, the highest it has been since 1983.

With grocery and gas prices skyrocketing, Canadians are trying to spend less as their personal costs go up. Almost half say they are now seeking out alternative modes of transport to avoid filling up their gas tanks.

As noted in the CBC article, some Canadians are already reducing their demand for gasoline; there is already some demand destruction taking place.

This bad news may reduce inflation because the economy has begun or will begin slowing. If inflation begins to soften, the Fed may not need to hike rates as aggressively as feared.

My own bias remains bullish on oil prices. Even though I am bullish, I will continue to watch the different factors affecting oil prices and react accordingly.

One last comment, the markets are volatile as evidenced by a recent VIX reading at about 27. That implies investors have a lot of uncertainty. I share that uncertainty because there are so many unknowns that may have a dramatic effect on the outlook for the overall economy and on the price of oil.