Intertwined. The Energy Report 05/05/2023

For oil, the expectations for a recession and the health of the banking system are intertwined. By almost every supply and demand metric, currently the move in oil is way overdone on the downside but that won’t matter if the regional banks continue to fail. Yet oil is surmounting an attempt to get back in line with supply and demand reality as there are signs that the banking woes could be stabilizing. Not only are we seeing a big rebound in PacWest Bank shares, the bank voted the next most likely to go under by the trader student body, but also the fact that the amount of money that banks were borrowing from the Fed discount window fell to $5.3 billion down from the $73.9 billion last week.

Part of that is that First Republic Bank failed and was bought out by JP Morgan, yet the steep drop is giving banks and oil a boost. Some also point to a complaint by The American Bankers Association, or ABA, that reportedly called on federal regulators to investigate significant short sales of publicly traded banking stocks that it said were “disconnected from the underlying financial realities.” The ABA said that it had also observed “extensive social media engagement” about the health of various lenders that was out of step with general industry conditions, reported Reuters, citing a letter written to the Securities and Exchange Commission Chair Gary Gensler. In other words, accusing social media members of trying to profit from starting rumors and runs on some banks.

You can be sure that our friends in the OPEC cartel are watching these developments very closely. Already group members have shown their displeasure with the way the market has been out of whack with market fundamentals, not to mention their displeasure with price caps and what they see as unjustified strategic petroleum reserve releases. Sources that I have spoken with believe that OPEC is only a few dollars away from another surprise production cut if this market does not recover soon.

Now a lot of folks were making a big deal about the Saudis lowering their official selling price for oil to Asia after three months of raising them. They said that this was a sign that demand in Asia was cratering.  Yet the official selling price (OSP) for June-loading Arab Light to Asia was reduced by 25 cents a barrel from May to $2.55 a barrel over Oman/Dubai quotes, according to a statement issued by state oil giant Saudi Aramco. The cut is less than the market expectation of 40 cents and a sign of confidence that the demand outlook in Asia in their opinion is still solid.

I spoke with former OPEC Advisor Anas Alhajji who said the only reason that Saudi Arabia adjusted the price at all was to appease some long-term customers about some contracts and the price cut was insignificant to the Saudis and not a sign that they were betting on a drop in Asian demand growth. He also dismissed tensions with Saudi Arabia and their best buddies Russia over Russia’s seeming lack of compliance to production cuts. He pointed to the fact that Russia’s Deputy Prime Minister Novak said that Russia is committed to its pledge of a 500,000 barrel a day output cut from February. The Saudis he said are not sweating it.

The other big issue with Saudi Arabia is the way the Biden administration bungled relations with our long-time ally. The heavy-handed foreign policy of trying to make Saudi Arabia a “pariah state” and freezing weapons sales to the country pushed Saudi Arabia closer to Russia, China and even Iran. Saudi Arabia recently normalized relationship with Iran, its long-term foe, even as Iran continues to compensate well tankers in the Strait of Hormuz. This has become a dangerous situation that the Biden administration is going to try to rectify. Reuters is reporting that, “White House national security adviser Jake Sullivan said on Thursday he will travel to Saudi Arabia this weekend for talks with Saudi leaders, as the United States seeks to bolster often-frayed ties with Riyadh. Sullivan, speaking at a think tank conference, also said the United States will “take the necessary action to ensure that Iran does not acquire a nuclear weapon” and still seeks a diplomatic outcome to the challenge posed by Tehran.” Now the big question becomes whether Mr. Sullivan will actually shake hands with Crown Prince bin Salman, or will he just give him a fist bump? Stay tuned! The World Is Watching.

India has been a major beneficiary of cheap Russian crude. The problem is that for India, it is getting harder to pay Russia for the oil. Reuters report that India and Russia have suspended efforts to settle bilateral trade in rupees, after months of negotiations failed to convince Moscow to keep rupees in its coffers, two Indian government officials and a source with direct knowledge of the matter said. This would be a major setback for Indian importers of cheap oil and coal from Russia who were awaiting a permanent rupee payment mechanism to help lower currency conversion costs according to Reuters.

Yet Russia has other issues. AFP Is reporting that, “A fire broke out at an oil refinery in southern Russia on Friday, a day after authorities confirmed a drone attack, Russian state-run news agencies reported. Agencies gave conflicting reports about the cause of Friday’s blaze at the oil refinery’s reservoir in the southern Krasnodar region’s Ilsky settlement.”

Now if oil prices get back in line with fundamentals we could bet a big recovery spike. But will that show up at the gas pump! Yes, but it should not be as bad as last year as refiners are coming to the rescue!

Javier Blass on Bloomberg wrote that, “Global net oil refinery capacity fell in 2021 for the first time in more than 30 years, but in 2023-24 it’s set to post its stronger two-year growth since 1977. He says that “RBC Capital Markets LLC, an investment bank, reckons that net global refinery capacity will increase by 1.5 million barrels a day this year, and by another 2.4 million next year. The combined 2023-24 boost is the largest two-year increase in net global refining capacity in 45 years, according to the bank. But Blass says that, “The buildup is, in part, a fluke: Refinery projects got delayed over the pandemic, with many of them now coming online simultaneously in places such as Kuwait, Nigeria, Mexico and China. Happenstance or not, the increase nonetheless marks a turnaround for the oil industry. In 2021, net global refining capacity fell for the first time in 30 years as the pandemic forced some plants to close. Exxon Mobil Corp. is emblematic of the new trend. Last month, it fired up the expansion of its plant in Beaumont, Texas. With 250,000 barrels a day of extra capacity, it is the largest addition in the US in more than 10 years.

Natural gas is struggling. The injection yesterday was slightly above average expectations, and the demand outlook right now looks subdued. Yet with signs that production is stalling and the outlook for demand rising, especially with the potential stabilization in banking, it might be time to start looking at calls. Zman’s Energy Brain points out that the natural gas inventory came out at 54 Bcf vs Street at +52 and our around +55 estimate. That puts storage at  2,063 Bcf  which is 507 Bcf above year ago and 341 Bcf above the 5 yr. Zman says that we  remain on track for a sub 3.8 Tcf peak in storage suggesting that prices are overdone on the downside.

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Phil Flynn

The PRICE Futures Group

Senior Market Analyst & Author of The Energy Report

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