A part of our long thesis for oil was the simmering tensions in the Middle East that historically, have not eased prior to further escalation. That is now coming to fruition. When one adds that to the market’s current misperceptions regarding the oil market fundamentals, we have the chance of a significant spike when these two events come to realization.
“Davidson” submits:
- US Crude Production holding 12.9mill BBL/Day
- US Crude Inv fall 11.5mill BBL settling 24.5mill BBL below 5yr move avg
- Refining Input rises 0.3mill BBL/Day, ending with 242.5mill BBL Gasoline Inv headed towards expected Spring peak ~260mil BBL Gasoline Inv
Current US Inventories sit well below previous levels which generated higher oil price response in past. The past never repeats as expected. The last period of high oil prices occurred during “Peak Oil” market psychology with speculators building additional storage capacity on which to base trades. In Wall Street parlance this oil was never meant for immediate consumption but meant to act as a hedge for speculative trading positions. The Wall Street joke is this oil was “Trading Sardines, Not Eating Sardines”. The storage capacity build was coupled with US Energy Information Administration strong recommendations that storage capacity be expanded from below a 20day Refining Input supply to a 30day level as an economic hedge to “Peal Oil”.
The explanation which seems to fit the facts is that there was a heavy commitment towards owning crude oil at the time Russia invaded the Ukraine in 2014. The US$( US Dollar) rose sharply causing oil prices to fall sharply in 2014. Oil prices plummeted due to inverse US$ correlations traders had placed in trading algorithms. Speculators took possession of this oil to reduce losses by continuing to sell futures contracts against the physical asset. US Crude Inventories soared. With this inventory rise US Crude Production peaked briefly June 2015 as lower prices made additional production non-economic. US Crude Imports (cheaper Mid-East oil) rose to counter the decline in domestic production. US Production declined till Nov 2016 as it became evident that heavy regulations on oil/gas exploration/production were going to be partially rolled-back. E&P companies having already begun to lower costs by adding technology and enhancing techniques lowered costs to such a degree that total production costs are today below $30/BBL. US Crude Production has grown 50% from 8.3mil BBL/Day Nov 2016 to 12.9mill BBL/Day today. US became a net exporter in 2019 with current Net Exports of 1.7mil BBL/Day. Global consumption has continued since 2011 uninterrupted at 1.74% annual growth with only a 0.013% variance.
Energy markets are if anything a very interesting mix of dynamically changing fundamentals and speculation. The more one takes into account the history of market psychology rife with misperception on prices, the massive inputs of technological improvements and compared these to the relatively steady baseline of Production/Consumption, the more one can see that market psychology is the major price determinant. This assessment is what the charts tell us.
The chart of US Crude Inv/5yr mov avg Spread vs $WTI indicates that current inventory levels at a 24.5mil BBL discount to the 5yr mov avg is well below levels in the past which justified the last period, 2010-2014, of higher $WTI. Events in Iraq/Iran have had some immediate impact, but if traders suddenly recognize and respond to the current inventory discount as in the past, $WTI could shift rapidly towards the $70-$80/BBL range in my opinion.
Prices are established by what investors believe lies ahead in our future, i.e. market psychology of imagined events. Expectations of higher $WTI based on past relationships may not come about as witnessed in the past. However, we do have a continuation of the current economic expansion with many investors remaining pessimistic. A shift in investor sentiment regarding their economic outlook will bolster investor participation and in my opinion we should see higher $WTI and equity prices.
