The Longest Short. The Energy Report 01/05/2024

For oil traders, bulls and bears, this start to the new year was like the longest short week ever. Coincidentally, the oil market also started the year with close to the longest short position ever. Before the year-end buying, John Kemp at Reuters pointed out that the net position across all three crude contracts had been reduced to a record low of 128 million barrels on December 12. Hedge Funds are the least long Energy Stocks in at least the last 5 years according to Goldman Sachs. Some of that lack of participation is because of hedge funds and banks being pressured into fossil fuel divestment in a world of woke capitalism and ESG investing which means buying the shares of companies that score highly on environmental and societal responsibility metrics as judged by folks that will profit by energy inefficacies and more political power.

Oil buyers have scattered as extreme volatility and low liquidity is causing large market swings back and forth. The market is trying to balance geopolitical risk factors versus demand expectations of doom and gloom and hopes that US production can keep rising in hopes that they can fill the void of OPEC production cuts. The algorithms are dutifully selling rallies most often in the 3 am central time hour and push it down until the buying comes in. Sometimes around 4 am and sometimes 8 am and sometimes not at all. Yet not only are we starting to see the start of a consistent US oil supply side drain, but the reality is that the market may be too complacent to the real risk to supply.

Goldman Sachs is warning today that an extended disruption in the Strait of Hormuz could double the oil price. They are calling it a “powder keg”.  While the market may see that is unlikely right now, is it any more unlikely that a rag-tag group of Houthi rebels can effectively shut down the Red Sea? If you believe Goldman Sachs’s assessment it would be wise to have some upward price protection.

The Biden administration is taking the long road back to refilling the Strategic Petroleum Reserve (SPR) that seems anti-ESG investing, down the road oil may be harder to find. Yesterday the Energy Information Administration (EIA) reported yet another large U.S. commercial crude oil inventory draw of 5.5 million barrels from the previous week. At 431.1 million barrels, U.S. crude oil inventories are about 2% below the five-year average for this time of year. Now if you throw in the Strategic Petroleum Reserve the supply deficit is much larger.

Do not take too much comfort in the massive product builds as it is more than likely year-end tax shenanigans. The EIA reported that motor gasoline supply inventories increased by 10.9 million barrels from last week and are slightly above the five-year average for this time of year. Distillate fuel inventories increased by 10.1 million barrels last week and are about 6% below the five-year average for this time of year.

Yet as HFIR research pointed out, “The massive drop in implied product demand + product build comes from year-end inventory gaming. This happens every year.”

I don’t believe that anyone can honestly say that the world is a more stable place since the Biden administration has been in power. It is not in the world of oil. Dan Tsubouchi of Energy Tidbits reported that because of the Houthi rebels, container shipping rate surged yesterday, a cost that will show up in inflation. As we know, the Maersk diversion around Cape of Good Hope will continue for the foreseeable future, as they “encourage customers to prepare for complications in the area to persist and for there to be significant disruption to the global network”. The Suez Canal handles 2% of world trade.

The reason the Houthis and Hezbollah have been able to thrive is its funding by Iran. Iran’s oil revenue is going through the roof as the Biden administration has failed to enforce sanctions on them. They believe that the Biden administration would not have the courage to enforce those sanctions so they are demanding higher prices for their oil from their customers.

If sanctions are enforced on Iran, China will still find a way to buy Iranian oil but at a huge discount. China would lowball bids because when the US enforced sanctions Iran’s oil was too hot for many to handle.

Now Iran is telling China if they want their oil, they’re going to have to pay a higher price. Reuters is reporting that, “China’s oil trade with Iran has stalled as Tehran withholds shipments and demands higher prices from its top client, tightening cheap supply for the world’s biggest crude importer, refinery and trade sources said. The cutback in Iranian oil, which makes up some 10% of China’s crude imports and hit a record in October, could support global prices and squeeze profits at Chinese refiners. The abrupt move, which one industry executive called a “default”, could also represent the backfiring of an October U.S. waiver on sanctions of Venezuelan oil, which diverted shipments from the South American producer to the U.S. and India, elevating prices for China as shipments dwindled according to Reuters. So far that has created a stalemate Iran feels very confident that they can demand a higher price from China for their oil. Iran must believe that oil demand is going to continue to be strong and that Biden won’t enforce sanctions. As you know China has already approved that their refiners can increase their oil imports by over 60% from a year ago.

The natural gas market could be on the verge of a huge move if cold weather comes as some expect. The natural gas charts look a bit overbought but also look like it could go parabolic if the white weather conditions hit. The Energy Information Administration did report another drawdown in supply. Working gas in storage was 3,476 Bcf as of Friday, December 29, 2023, according to EIA estimates. This represents a net decrease of 14 Bcf from the previous week. Stocks were 553 Bcf higher than last year at this time and 399 Bcf above the five-year average of 3,077 Bcf. At 3,476 Bcf, total working gas is above the five-year historical range.

Yet last year the EIA said that U.S. Henry Hub natural gas prices in 2023 were the lowest since mid-2020. They said that the U.S. benchmark Henry Hub natural gas price averaged $2.57 per million British thermal units (MMBtu) in 2023, about a 62% drop from the 2022 average annual price, according to data from Refinitiv Eikon. Record-high natural gas production, flat consumption, and rising natural gas inventories contributed to lower prices in 2023 compared with 2022. The monthly average Henry Hub price was below $3.00/MMBtu in every month except January, with the lowest monthly average in May at $2.19/MMBtu.

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