Macro: Sandcastle economics
Invest wisely in Q3 2024: Discover SaxoStrats' insights on navigating a stable yet fragile global economy.
Head of Commodity Strategy
Summary: Crude oil is once again challenging the upper end of the trading range that has prevailed for the past six weeks. Relative calm market action during this time has, however, been hiding a market in continued turmoil where major opposing forces have managed to keep it rangebound. However, Russian sanctions and the departure of international service companies hurting Russias ability to maintain production, as well as easing lockdowns in China both point to a renewed risk of higher prices.
Crude oil is once again challenging the upper end of the trading range that has prevailed for the past six weeks. Relative calm market action during this time has, however, been hiding a market in continued turmoil where major opposing forces have managed to keep it rangebound. During this time the U.S. government has injected millions of barrels in a failed attempt to suppress the price while Chinese demand has suffered due to its zero-Covid Strategy.
The fact the market has not fallen below $100 highlights the underlying strength with tight supply of key fuels, self-sanctioning of Russian crude oil, OPEC struggling to increase production and unrest in Libya all supporting the market. With China potentially starting to ease lockdowns and with unrest in Libya still growing, the short-term price risk remains firmly skewed to higher prices.
During the past few weeks, the focus has turned from a rangebound crude oil market to the product market where the cost of gasoline, diesel and jet fuel have surged to levels not seen in years, if ever. The combination of refinery maintenance, a post pandemic reduction in capacity as well as self-sanctioning of Russian products have all led to incredible tight markets. Especially in North America where refineries are running flat out to produce what they can, and in the process benefitting from mouthwatering margins.
As a result, strong demand for WTI crude oil, both from domestic and overseas refineries, has driven all but removed its usual discount to Brent crude with the soon to expire June contract (CLM2) trading above the July Brent contract (LCOM2).
While the diesel crack, which reflects the profit in dollars per barrel of refining a barrel of WTI to NY ULSD (Ticker: Hoc1) has eased a bit during the past week, the gasoline crack, meanwhile, continues higher with US motorists currently paying a record average price for gasoline around $4.5 per gallon. Later today the US EIA will release its weekly stock report and expectations, backed up by the American Petroleum Institute’s report last night, point to another significant draw in US stocks of crude oil and gasoline.
So far, we are seeing no signs of demand for diesel and gasoline having started to suffer, and with the US driving season still weeks away, the risk of even tighter markets into the busy summer demand season remains.
Since the early March peak across key commodities the Bloomberg Industrial Metal Index has slumped by 25%, the agriculture sector is up 3% while the energy sector has risen by close to 13%, thereby bringing the year-to-date gain to 72%. Unfortunately given the market behavior during this time only a sharp deterioration in the outlook for global economic growth may prevent the price of crude oil from rising further during the coming months.
One potential olive branch to the market could be easing sanctions on Iran and Venezuela paving the way for increase exports. On Tuesday, the Venzuelan government confirmed that the US had authorised American and European oil companies to start negotiations to resume operations. The move will allow American oil company Chevron, the only one that still has a presence in Venezuela, to negotiate its license with state-owned oil company PDVSA to continue operations in the country. Venezuela, a +3 million barrel per day producer around the turn of the century has since seen its production slump to around 700,000 barrels per day due to US-led sanctions on the governments of Chávez and Maduro.
While the soon-to-expire June WTI contract has broken higher, Brent has yet to follow as China lockdowns continue to curb further price gains. We do, however, see the short-term risk of higher prices with demand destruction not yet meaningful enough to offset a market in tight supply.
Global energy stocks are the cheapest in 27 years writes my colleague Peter Garnry in his latest equity market update. In it he says that global energy companies are currently valued at a staggering 10% free cash flow yield with an outlook that is suggesting higher forward prices on oil and gas in the coming years as the world tries to plug the hole after Russian sanctions. Energy companies are massively profitable with 18% return on equity, but in our grotesque capital markets of 2022 investors are mostly talking about buying the dip in technology stocks. As we recently wrote in our note the inconvenient truth about energy and GDP the world will need a lot of oil and gas over the coming decade, so the investor outlook in energy stocks remains very positive. In his update he mention some of the largest energy companies in the world measured on market cap.
Disclaimer
The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.
Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer)