Phil Flynn is writer of The Energy Report, a daily market commentary discussing oil, the Middle East, American government, economics, and their effects on the world's energies markets, as well as other commodity markets. Contact Mr. Flynn at (888) 264-5665
The Great Fed Commodity Crush. The Energy Report 05/17/2023
Fed officials seem oblivious to signs that they may have done too much damage to the economy. The goal is to ward off the inflation they did not see coming, but now they are even wondering out loud as to whether a pause in rate increases was appropriate even as banks fail data shows that retails are plunging, and consumer debt is soaring.
Comments from Chicago Federal Reserve President Austan Goolsbee who said that the vote for the Fed to pause on rate increases was a “close call” and that t it was “too premature” to be discussing interest rate cuts, helped the dollar to rally and crush commodities. The New York Fed John Williams also said that inflation was still too high and that gave the market the sense that the Fed is going to drive the economy into a recession, allowing commodities like oil and copper to ignore what could be a significant growing shortfall of supply. They both seemed to ignore more evidence that they may have done enough damage already. It’s data like US retail sales that hit the lowest level or peripheral evidence like reports that a firm like Home Depot saw its biggest revenue miss in 20 years is causing concern.
Yet the Fed speakers signaling that interest rates will stay elevated led to a commodity price crush which might have been their real mission.
It was not just oil that took a hit, but grains got crushed along with precious metals and even copper that is supposed be in a shortage situation in a couple of months. The question becomes is oil too much focused on the Fed and the debt ceiling and ignoring its own fundamentals that could lead to a coming oil price shock?
Even an overnight surprise 3.69-million-barrel increase in crude oil supply should not overshadow another 2.46-million-barrel drop in gasoline supply and an 886,000 barrel drop in distillate supply. The drop in gasoline supplies adds to a deficit where supply in real ternas is at the lowest level since 2014. Even tighter if you look at demand. Diesel supply are even at a larger deficit of 24 million barrels (-18% or -1.39 standard deviations) and this too had widened from -12 million (-9% or -0.73 standard deviations) in early March according to data compiled by Reuters.
This comes on the same day that The International Energy Agency raised its forecast for 2023 global oil demand by nearly 400,000 barrels a day, reaching a record annual daily average of 102 million barrels. Yet as the oil markets ignore record demand and tight product supplies, even as the Fed inspired oil price crash, could enhance a shortage and is already leading to what may be a big drop in US oil and gas production that will leave the US more dependent on OPEC plus for supply.
The FT reports that US oil and gas drillers have hit the “halt button.” The FT writes that, “After slowly climbing since the depths of the pandemic, the number of oil and natural gas rigs at work in the country has declined 6 per cent since the beginning of the year to 731 last week, according to Baker Hughes, the oilfield services company. Almost 2,000 rigs were running in the middle of 2014, when the shale revolution was at a peak. Last week the number of gas-directed rigs dropped by 16, or 10 per cent — the steepest weekly fall since 2016.”
Part of the problem with the reverse in US oil and gas production is not just price but the fact that the Biden team has failed to enforce sanctions on Iran, Russia, and Venezuela. They also discouraged investment with attempts at price manipulation with Strategic Petroleum Reserve releases as well as anti-fossil fuel move like executive orders that included a moratorium on new oil and gas leases on federal lands and waters, revoking the permit for the Keystone XL pipeline, or directing the Environmental Protection Agency to review and strengthen methane emissions regulations. Rejoining the Paris Climate Agreement that allows China and India to pollute while restraining US oil and gas producers and taxing them to send that money to India and China to develop green energy while China sells us rare earth minerals and wind turbines. Not to mention accusing the US oil and gas industry of being racist and directed federal agencies to consider the impact of US energy production policies on disadvantaged communities and establishing a White House Environmental Justice Advisory Council with the goal of suing US oil and gas companies.
Yet Iran and Russia and Venezula, which I am are sure are very concerned about environmental justice, flourish. Javier Blass at Bloomberg wrote, “almost all the unanticipated production is coming from OPEC+ countries that are under Western sanctions: Russia, Iran and, to a lesser extent, Venezuela. Put simply, the black market for oil is booming. If one has the appetite – and the stomach – to buy crude from Moscow, Caracas or Tehran, the barrels are there. Better yet, they’re available at a discount.”
Blass writes, “Iranian production hit a four-year high last month, up nearly 50% from mid-2020, just as Tehran accelerates its nuclear program and intensifies a crackdown on domestic opposition. Much of that oil is ending up in China under different guises, often rebranded as originating in Malaysia” according to his sources.
Blass also say that, “Right now, the oil market is paying too much attention to the political and economic ups and downs in Washington. True, the US is still the world’s largest oil consumer, swallowing two of every 10 barrels pumped worldwide. But America isn’t the oil market. Its consumption lead has narrowed significantly in recent years, and in 2023 the combined consumption of China and India (21.4 million barrels a day) is expected to be larger than the US (20.3 million). The strength in the developing world matters. “We are seeing very strong demand, especially in Asia. Chinese recovery has been faster and stronger than expected,” Toril Bosoni, the IEA’s head of markets, told Bloomberg Television on Tuesday. “This is contrasting with the sort of economic gloom and the concerns we see for the global economy.”
Yet despite weakness in oil, natural gas held up. In the near future tight supply and demand will matter. We think bullish option strategies are at value prices.
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