HDRO - Pick Your Own Crude Oil Price: Regardless It's Heading Higher

2023-09-19 01:18:28 ET

Summary

• Massive shortage in production and refining continues, with a shortfall of almost a million barrels per day.
• Demand remains strong, hitting a record of 102.8 bpd in July, with forecasts of deficits in the future.
• The oil market is at risk of a significant correction, but charts suggest prices above $100.

Opinions defining the next direction for crude oil ( CL1:COM ) pricing continues. The bantering for position seems relentless. Those claiming weakness watched with horror, the price running against them. The opposite was true a few months ago. What seems clear and continues are three real forces: fear of demand destruction from poor economies on the world stage, tight markets in spite of fear, and one major supplier in need of higher prices. In essence, the determining factor resides in the hands of that major supplier unless a total meltdown of the world occurs. This continues our coverage of the crude oil markets. In the past, we pointed out that crude fundamentals continue bullish with its lack of investment and strong demand. We offer our readers thoughts letting them decide, is it a health food market or time to party? Let's head for some lunch. Please feel free to order your choice.

Massive Shortage Continues

It's clear, a steep shortfall in production and refining exists. From our last article, we once again include this table :

Continuing through the rest of the summer, the dearth of production only became more apparent.

The average shortfall for the summer equaled almost a million barrels per day while production slowly increased from the low 12 million to near 13 million. The average production of 12.5 million isn't even close to closing the gap.

Last week, inventories increased, but we suspect that it's a one-week flyer, which sometimes happens with this data.

But Will It …?

The obvious question is will it continue? Will demand remain strong? The multitude of opinions continue.

When continuing with the bullish side, arguments include tight production capacity, strong demand and one country attempting to control it all.

We begin with this from OilPrice ,

"Earlier this week, media reported that oil production from the members of OPEC had fallen to the lowest since 2021 - or OPEC Output Plunges by Most Since 2020 as Saudis Deepen Cuts - BNN Bloomberg , depending on the source . . —thanks to voluntary production cuts from Saudi Arabia and involuntary declines in Nigeria, Angola, and Libya."

Goldman Sachs restated the obvious that demand in July hit a record of 102.8 bpd. This was stronger than most analysts expected. The bank forecasts deficits of 1.8 million bpd in the 2nd half of 2023 and just under a million next year.

The price increases will interfere with the Fed's challenge to control inflation. The August number came in "hot" with the total equaling 7.4% and the core excluding food and energy at 3.7 both significantly higher than the month before. (On a personal note, we wonder, seriously wonder, why the second number even matters. For those of us on fixed income, the bulk of our expenses are food and energy.)

The International Energy Agency (IEA) reported slightly higher numbers at 103 million bpd demand on a world-wide basis. At these rates, world inventories will drop by 2mb/d in the 3rd and 4th quarters. Commodity analysts, Standard Chartered, estimates August demand slightly above June and at record levels. This respected group expects 4th quarter Brent averages at $93 with highs during the quarter above $100. We agree, more comes later.

It also doesn't help with the financial chokehold on the North Sea. In recent weeks, world banks have met trying to foster support for badly needed investment. Few takers are expected with most loans being targeted at new energy sources.

Saudi Arabia and Russia love the outcome. Russia, under production restrictions from the Ukrainian War, and the Saudis with its meager 1 million production cut per day, are strangling the world with these minor cuts. It really is that tight.

The bullish story continues with what was once about gasoline demand now changing toward diesel. Supplies of diesel remain ultra tight on a world scale. Our own data shows gasoline range bound between $2.5 and $2.9 along the Gulf Coast. But diesel prices, in the same region, increased a dollar during the September quarter driven by increases in demand. The long traders are out in force. It is driven primarily by low inventories at the time of the year when demand really picks up. One analyst wrote, "“Demand is expected to increase month-on-month to November,” Howsham added."

And finally,

" The big picture is the extended voluntary production cuts by Saudi Arabia and Russia. The deficit is now broadly equal to the Saudi additional voluntary cut ," Andrew Lipow, president of Lipow Oil Associates in Houston, told Reuters. The two countries have extended production cuts of 1.3 million barrels per day (bpd) of crude to year end, which Bank of America has predicted will lift Brent futures above the $100 a barrel threshold before the end of the year.

The story doesn't end with the bulls. The bears continue their loud noise. Their argument resides around coming higher interest rates associated with the higher inflation noted above and from grave growth concerns in China. With energy prices back on the rise and inflation following with it, the Fed can't be yet finished .

“It would be foolish for any central bank to declare victory,” Randall Kroszner, a former governor of the US Federal Reserve System and now an economics professor at the University of Chicago Booth School of Business, told CNN this week."

The perma bear, the Gunvor Group, argues,

"The oil market is at risk of a “significant correction” in the last quarter of this year or the first quarter of 2024, Frederic Lasserre, Global Head of Research & Analysis at Gunvor Group, told Bloomberg in an interview at the Asia Pacific Petroleum Conference (APPEC) by S&P Global Commodity Insights in Singapore.

“It’s very possible even without much change in fundamentals or balances,” Lasserre added."

In the end, it's about "the 1 million barrels per day" voluntary cut within ultra-tight markets.

The question becomes what price does Saudi Arabia want? Some argue that the price equals what the economic marketplace can stand, something in the middle $80s. We aren't so sure.

The Chart Predicts Direction

Investors can gain a handle on future prices through charts. The five-year chart, from Trading Economics , shows a dark line at $90, a significantly important point of resistance or support.

Recently, prices broke above $90 signaling higher movements. The next point of resistance is in the $105 to $115 range. The chart strongly suggests prices above $100. We expect a price range in the $110-$115 before this move is over.

And Paying a Volatility Price for Dumping Long Contracts

And may we remind our readers that this level of volatility came with the lost level of stability from:

"The actual influence of soaring funding costs on the oil market is that traders are destocking and selling off physical barrels because the costs to hold crude, and the penalty for keep holding that crude if demand tumbles in a deep recession, have spiked."

In the spring and early summer, traders, banks and others dumped large lots of long contracts in order to cut interest payments. Without this cushioning effect, the result will be more volatility.

Risk

Oil is heading higher unless recessionary demand destruction pulls the rug out from under it, something that hasn't yet appeared. It might. The idea that economics drives pricing, believed by some, seems off the mark to us. The price, in our experience, drives itself. For those holding investments in companies which move with oil, in our view, the upward move still has legs. The party isn't over. Order the junk food. It is still in vogue. We understand we could be wrong.

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