Class is Back in Session with High Energy
WTI's Post-Summer Rally has Energy Traders Excited
Hi Everyone 👋,
Just like lunchboxes and backpacks, Oil is back baby!
Well, at least for now…
The dominant headline of the week was the advance of WTI trading around $88 on the back of production cuts.
After the summer retreat in energy prices, we’re now seeing a rally as different demand and supply forces teeter-totter back and forth.
Energy, particularly Oil, is always a very tricky area because of the amount of moving pieces. The entire global fabric is involved in the push and pull sides of energy production. Sprinkle in a legalized cartel, new technology, the green wave, and heavy politicization and you have a volatile playground.
If you look at the supply and demand inputs into an economic model, it’s enough to make your head spin like a merry-go-round.
Now that summer recess is over, class is back in session, so let’s open our textbooks, to the next chapter in the energy picture.
Oil’s Recent Run 👉 Flirting with $88
Push and Pull👉 Supply and Demand Dynamics
Energy Prices Ripple Effect 👉 Impact on Inflation
Let’s get started!
1. Oil’s Recent Run 👉 Flirting With $88
Crude oil prices jumped on Tuesday morning after Saudi Arabia and Russia said they are extending voluntary oil production cuts through the end of the year.
Back in April, OPEC+ (OPEC plus Russia-led allied nations) pledged to reduce oil production by around 1.1M barrels per day (bpd) from May onward. They have now extended this further to 1.66Mbpd.
Extending the WTI chart further, we can see the lagged impact of production cuts that led to the late-summer rally:
Since this original cut was not announced through the official decision-making body, this was deemed a “voluntary” cut, leaving it as clear as mud as to how strictly the members involved would adhere to the limitations.
Before the original cut announcement, OPEC’s leader, Saudi Arabia, slashed its output by 519kbpd in April. As of July, Saudi Arabia’s cut increased to 1Mbpd, which amounts to roughly 10% of the nation’s usual production, and more than 1/3rd of all of OPEC cuts announced last fall. Russia’s announced cut is an additional 300kbpd.
Keeping track of all of that?
Net new information = cuts on top of cuts.
Something to keep in mind with the OPEC+ production cut announcements is that other members are exempt from OPEC’s system of oil production quotas. Countries like Iran have increased their production quotas, although the relative amounts pale in comparison.
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2. Push and Pull👉 Supply and Demand Dynamics
If you think about supply dynamics, it’s the net new information amongst the largest volume producers around the margins that matters. Here’s the leaderboard:
However, global production is only one component of supply. We also have inventory levels. Inventory levels gyrate widely across different sources, but the general trend has been down:
Source: Kpler, @ericnuttall : x.com
A key tool to look at when it comes to the supply picture in the US is the Strategic Petroleum Reserve, which is an emergency stockpile of petroleum maintained by the DOE:
There was a substantial release of this reserve at the end of March in order to alleviate higher prices. The release and buyback of this reserve is another input intended to control prices.
While production and inventories are on one side of the equation, demand is on the other. The world’s second-largest economy, China is crucial to driving demand into the remainder of the year, and unless you’ve been hiding under a rock, you know that the picture in China isn’t looking too pretty. Growth has been sluggish and stimulus has fallen short as the government raised the key lending benchmark by less than expected.
So while inventory and production are being cut, demand is softening at the same time. Recession calls coming to fruition, meanwhile, would also mean an even further slowdown in global demand. Good luck plugging all of that into your Oil price prediction forecasts.
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3. Energy Prices Ripple Effect 👉 Impact on Inflation
Instead of trying to forecast where oil prices are going to go, let’s take what we know at face value and think about the implications. If we go back to spiking inflation in the United States, we know that a lot of this was due to rising energy costs:
Energy, the turquoise bar there, contributed a significant portion of inflation around the peaks that we saw in 2022. In 2023, the opposite has been true, as energy has been a significant net detractor.
Remember, the energy bar goes by price. However, the impact of higher energy prices ripples through the economy as it is used as a means of production and transportation. We’re now seeing the recent downtrend in energy prices reverse, which could complicate JPow’s battle against the whole inflation thing.
Where are energy prices going? I don’t know, I’m not Helima Croft.
But the recent trends are up, which could put short-term pressure on higher inflation just as we’re getting everything under control.
There’s always something exciting going on in the market, and with so many moving pieces, we have a lot of uncertainty.
Only one thing is certain… summer is over and pumpkin spice lattes are now upon us…
Until next time. Always Yours. Incessantly Chasing ROI.
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The author of this newsletter owns ETF’s (exchange traded funds) that may hold ownership interests in the companies discussed in this newsletter as of the published date of this newsletter.
1 Worldometer: Oil Production by Country (September 7, 2023): https://www.worldometers.info/oil/oil-production-by-country/
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