Specious Argument

For July, I am maintaining my June forecast for West Texas Intermediate (WTI) oil to range between $65 and $85 per barrel. As I write this blog entry on June 30, WTI is about $70.50 per barrel.

Once again, I had expected stronger prices. Some of the pundits that I follow expected that once the debt ceiling crisis was past, oil prices would rise. Some even stated that OPEC+ did not need to cut further at their early June meeting. Once the debt ceiling issue had passed and even though the Saudis announced a cut of a million barrels per day for July, oil prices still stagnated. One can only imagine prices if the Saudis had not cut.

The EIA revised its US demand for April upward based on monthly data. Below is a back-and-forth discussion between zerohedge and Javier Blas from Bloomberg.

The Biden admin will not stop fabricating data and draining the SPR to push the price of oil lower https://t.co/mxYq4hyCnY

— zerohedge (@zerohedge) June 30, 2023

They are not "fabricating data". We are all well aware of the problems with weekly estimates vs monthly data based on real survey. The problem is a long-standing one, and was present similarly with Republican and Democrat administrations.

— Javier Blas (@JavierBlas) June 30, 2023

When is the last time demand estimates were revised lower

— zerohedge (@zerohedge) June 30, 2023

In January 2023:

Weekly data: 19.674m b/d. Monthly data: 19.539m b/d

For a revision (lower) of -135,000 b/d | #OOTT

(So that's four months ago, as current data is April)

— Javier Blas (@JavierBlas) June 30, 2023

Javier Blas wrote an article on May 16, 2023, “The Oil Market’s Real Weakness Is Supply, Not Demand” (subscription may be required), where he stated the following:

Is the extra supply from Russia, Venezuela and Iran a sign that the Western sanctions aren’t working? No. It’s a sign the sanctions prioritize keeping the oil market well supplied, even if that means that Moscow, Tehran and Caracas can sell oil. Ignore Western politicians talking about using sanctions to cripple rogue petro-dictators; what they want is to cripple inflation. For now, the strategy has worked. It remains to be seen if it will survive the summer, when oil demand growth is likely to accelerate.

Strong supply from Russia and Iran, China’s tepid recovery, and likely higher interest rates all weigh on oil prices. The US no longer tapping the strategic petroleum reserve and the Saudis seemingly determined to strengthen the physical market should, at a minimum, keep oil prices steady.

A June 29 Bloomberg article “Brent Oil Set for Record Run of Quarterly Losses on High Supply” (subscription may be required) states the following:

The outlook for the second half is mixed. Some analysts have forecast that the market will tighten, in part due to the end of seasonal maintenance. Yet US Federal Reserve Chair Jerome Powell and some of his peers have said more interest-rate increases are likely, which would drag on energy consumption.

“We fear that market apathy and lack of risk deployment will compound further if the global physical market does not tighten,” Royal Bank of Canada analysts Michael Tran and Helima Croft wrote in a note. “This could end up being a lost year for the oil market as risk remains on the sidelines.”

In the video accompanying the above article, Amrita Sen of Energy Aspects worries that sovereigns, perhaps PEMEX of Mexico, may hedge its output. When sovereigns go to the market to hedge, that puts downward pressure on oil prices.

Regarding the recent developments in Russia, I am ignoring them because I do not believe they will affect oil prices.

My own bias is that prices should stabilize or move higher from here. My bullishness has been wrong so far this year. So I look forward to seeing how July unfolds.

I hope everyone enjoys a great start to their summer vacation.

For June, I am decreasing my May forecast by $5 per barrel for West Texas Intermediate (WTI) oil to range between $65 and $85 per barrel. Late Tuesday, May 30, WTI was about $69.50 per barrel.

I had expected stronger prices in May. The prices weakened because of numerous factors including strong Russian oil exports, continued uncertainty with the debt ceiling, fears of one or two more rate hikes further weakening the economy, weaker than hoped for gasoline consumption over the Memorial Day weekend, and uncertainty about the outcome of the OPEC+ meeting being held the first weekend in June.

The opening two paragraphs from the May 30 Bloomberg article “Russian Oil Flows Stay High Three Months Into Pledged Output Cut: Seaborne exports dip but remain 270,000 barrels a day higher than February, the baseline for output reduction,” states the following:

Russian crude oil flows to international markets are edging lower, but still show no substantive sign of the output cuts that the Kremlin insists the country is making.

Four-week average seaborne shipments, which smooth out some of the volatility in weekly numbers, fell for the first time in six weeks in the period to May 28, slipping to 3.64 million barrels a day. But crude flows to international markets remain elevated and are still more than 1.4 million barrels a day higher than they were at the end of last year and 270,000 barrels a day up on February, the baseline month for the pledged cut.

Even though a tentative agreement has been reached on the debt ceiling, there is still some uncertainty as outlined by the May 30 Reuters article “Oil slides 4% on worries about US debt ceiling, OPEC+ talks.”

NEW YORK, May 30 (Reuters) – Oil prices fell more than 4% on Tuesday on concerns about whether the U.S. Congress will pass the U.S. debt ceiling pact and as mixed messages from major producers clouded the supply outlook ahead of the OPEC+ meeting this weekend.

The Personal Consumption Expenditures (PCE), a favorite Fed inflation gauge was hotter than expected for April at 4.4 percent, up from 4.2 percent in March, which might cause the Fed to raise rates again. If the Fed raises rates again, that will likely slow the economy and likely further decrease oil demand.

BREAKING: According to GasBuddy data, US gasoline demand over the Memorial Day weekend (Thur-Mon) so far is down 1.1% from 2022. Once Tuesday is complete, we'll add it to see the total weekend.

— Patrick De Haan ⛽️📊 (@GasBuddyGuy) May 30, 2023

The above tweet from Patrick De Haan shows that gasoline demand was down over this important holiday weekend and kickoff to the driving season.
As mentioned in the Reuters quote, there is uncertainty regarding the upcoming OPEC+ meeting.

The debt ceiling issue ought likely to be resolved this week, and the economy remains reasonably strong. Because historically OPEC+ does not like extreme oil price volatility, it likely will put measures in place to ensure that supply does not overwhelm demand at current prices. For these reasons, I am biased to oil going higher, especially as the driving season gets underway.

Last month, I provided a YouTube link to Paul Sankey giving his thoughts on oil. Here is another YouTube link where again he provides his views. Unlike me, he is less sanguine on oil prices for the rest of the year. Even though my outlook is different than his, it is good to consider opposing viewpoints.

Whether agreement on the debt ceiling passes both houses before the deadline of June 5 and what OPEC+ decides this coming weekend will strongly influence what happens to the price of oil for June. While I have a bullish bent for June, I certainly have no unique insights.

For May, I am increasing my April forecast by $5 per barrel for West Texas Intermediate (WTI) oil to range between $70 and $90 per barrel. On Friday, April 28, WTI was about $76.50 per barrel.

The last two months have been tumultuous. Two months ago was the start of another banking crisis, and one month ago, OPEC+ announced production cuts to start in May. Both of those events affected WTI’s price. After OPEC+ announced its cuts, oil rallied, though much of that rally has been lost since mid-April.

I lean bullish because many oil pundits expect a strong second half to 2023 and the driving season is rapidly approaching.

Paul Sankey, who is often seen on CNBC and who now runs his own research company, produced a YouTube video while visiting Calgary, Canada in mid-April. In his video, he also expressed a bullish outlook for oil.

The banking crisis has not completely resolved itself. In fact, according to the Financial Times article “JPMorgan, Citizens and PNC submit bids for First Republic” (subscription required), US regulators are racing to sell all or part of First Republic before the markets open on Monday, May 1.

At least three large banks have submitted bids to buy all or part of First Republic, the embattled California lender that US regulators have been racing to save this weekend.

Among those that have put in offers are JPMorgan Chase, PNC and Citizens, according to three sources with knowledge of the situation.

Along with the banking crisis, many continue to worry about the health of the global economy.

Because OPEC+ will start its cuts in May, its effects have not yet been felt in the physical markets.

On balance, I continue to lean bullish. While the banking crisis and general state of the global economy remain a concern, the global economy should remain strong enough to continue to demand more oil and the oil cuts will likely create a floor for prices, if not strengthen prices.

For April, I am reducing my March forecast for West Texas Intermediate oil (WTI) by $5 to range between $65 to $85 per barrel. As I write this blog post in the evening of March 30, WTI is hovering around $74.40 per barrel.

Last month I mentioned that as long as the general economy remains healthy, prices should strengthen. Of course, that did not take into account the March banking crisis that everyone is now well aware of. It seems when there is an adverse economic development, oil seems to immediately and disproportionately suffer, perhaps because traders remember all too well how oil suffered during the great financial crisis in 2008 and, again, during the initial COVID-19 breakout.

There were other factors, too, however. There was a negative gamma effect heading into options expiry. The negative gamma effect of financial institutions having sold protective puts on WTI oil prices to various producers. As WTI approached key strike prices, those financial institutions needed to sell oil futures to hedge themselves. A March 26, 2023, the Wall Street Journal article “How Options-Hedging Turbocharged Oil Volatility: Trade amplified a price drop to 15-month lows and now could help fuel a rebound” (subscription required) provides a more in-depth explanation.

Earlier this month, oil’s steepest weekly slide in almost three years accelerated as futures approached levels where many producers owned derivatives designed to lock in prices. As declines mounted, banks and trading firms on the other side of those trades had to unload crude to mitigate potential losses, investors said, dragging benchmark prices to 15-month lows.

Now, many expect similar dynamics could add momentum to any rebound if the economic outlook improves—leading to more expensive oil that could increase the cost of gasoline and diesel later this year. It is the latest example of how volatility in financial markets can spill into the real world, shaking an oil industry stretching from the shale basins of Texas to refineries in China.

The recent retreat “in many ways had not a lot to do with oil,” said Ben Luckock, co-head of oil trading at Trafigura Group, at an industry confab hosted by the Financial Times last week. “We got caught up in the macro world again, which happens all the time. It’s OK,” he added. “But it distorts what happens in the future.”

The article displays a graphic from Standard Chartered Commodities Research where it shows the producer put-option volumes skyrocketed from about 50 thousand barrels per day to nearly 300 thousand barrels per day at a strike price of $70. In other words, as WTI approached $70, financial institutions were forced to hedge their short put positions.

As an aside, the article further mentions that Mr. Andurand, who runs a $1.3 billion energy hedge fund, believes oil prices could hit $140 per barrel by the end of the year. He is likely referring to Brent prices, which tend to be $5 to $10 higher than WTI prices.

In addition, there were technical price levels that were breached, and the number of long oil futures was at recent lows. All these factors likely reinforced each other to help drive WTI prices down to the mid $60s before rebounding this week.

Often when oil prices suffer a significant fall, a passage of time is required before traders and investors regain their confidence to push oil prices back to prior levels. Furthermore, the banking crisis will cause some, if not most, banks to scale back their lending as they fortify their financial positions. This scaling back in lending practices will do some of the Fed’s work in slowing the economy, which is likely to be a drag on oil prices.

Regarding the economic effects of contracting credit, Ray Dalio wrote two interesting books regarding how the economic machine works: first, Principles for Dealing with the Changing World Order: Why Nations Succeed and Fail, and second, Principles for Navigating Big Debt Crises. Please note that I have used Amazon affiliate links for both books. Also, I encourage you to view his 31-minute video “How the Economic Machine Works.”

Because of the increased uncertainty caused by the banking crisis and the general skittishness of investors and traders, I have lowered my price range by $5 per barrel for April. In general, I am still bullish on oil and expect prices to strengthen in the second half of the year.