Dear investors,
I find myself writing another update for the Oil & Gas market, especially as we are moving away from the March and more recent June highs of $120/bbl. With many of our plays given out this year in this sector, it is now time to reflect and a give review and outlook. In the next few newsletters, I shall be outlining out existing FX positions along with new price targets. We are also working hard looking at three new FX pairs.
Globally, the petroleum market both upstream and downstream has been looser as of late. Light crude prices are off about 20%, while US refined product prices have declined 30%. The looser marketplace of late reflects softening US gas consumption, lacklustre demand in China, and Russia’s ability to avoid both western sanctions and boycotts. Rather than supply deficits, the market is probably in modest surplus presently. We have been riding the trend in crude since $40/bbl back in September 2020.
We are now starting to believe that the trend in crude prices will be broadly flat for the remainder of 2022, subject to the caveat that Russia continues to largely offset sanctions and boycotts. Ironically, a successful regime could result in a surge in prices, where one could not rule out $150/bbl Brent. Quite simply, I am seeing very little spare capacity to offset the loss of around 8mmb/d of Russian exports in any plausible time frame. With this uncertainty, it is hard to say how much lower crude can go, even with the large EIA draw this week coming in at -7m vs. an expected build, which has now given some much needed support around $90/bbl.
Talking about demand, the US in Q1 was running for a time at a record 22mm b/d, since then, Intel says it’s sitting around 20.5mm b/d, down 2.9% from a year earlier. China, on the other hand, the second largest oil market after the US, is showing signs of demand weakness. Most people are not talking about the fact that China is actually having its weakest year for demand growth in perhaps 30 years. Based on our compiled EIA date, the underlying issue has been Covid restrictions on mobility in major cities. Electric car manufacturers also growing in China, such as NIO, are driving away demand for ICE. We believe there are two ways to play this;, the first is to load up heavily on Chinese transportation companies that are beginning to reopen the floodgates,; the second is a correlation we have been tracking since the second official lockdown in China, that is, many of the LNG tanker companies based in China have actually not been hit in terms of share price decline yet. It is our belief some of these companies are reporting fraudulent results, as when tracking some of these vessels, a large proportion were seen to be static, yet revenue on many of these companies is barely down -10% from pre-covifd levels. We believe there’s something here.
Another notable area that many investors seem to be brushing over is product prices. As the surge looks to be winding down, I would like to remind everyone of the surge we had back in 2021 for US wholesale refined products. As of late July, US Gulf wholesale prices for regular gasoline and diesel were $2.99 gallon and $3.47 gallon. Retail prices in real terms so far peaked in early June at $4.94 and $5.57. These were slightly below the 2008 highs. It doesn’t take a genius to work out the reason prices are dropping is due to narrowing refining margins and crack spreads. The latter reflect rising refining output as utilisation rates have climbed to around 95% from 90% in late 2021. At this stage and level of utilisation the market opens itself up to softening demand. Given peak utilisation is always measured at 100%, which results in certain price drops, we do see more opportunity going forward for large swings south before quick rebounds. Again, like this week’s EIA print moving the market 5%.
But talking about refining crack spreads-there is some notable information. The surge we saw in H1 2022 outpaced crude and led to a dramatic widening in crack spreads internationally. For example, based on the most common 3-2-1 spread, the conversion margin on refining three barrels of WTI into two barrels of gasoline and one barrel of diesel widened from about $20/bbl in Dec21 to $60/bbl in June22. That has provided a highly lucrative backdrop for American refiners, some of which still only appear to be trading at very low multiples of earnings. Which is way above the typical $10-20bbl range that is normal. The spread as of the end of last month is $37, well down from June’s $60 high but still at an elevated level historically. Going forward, we now have to make a decision on where the spread will go. Using moving averages we can get a better handle on this. 3M moving averages tell us that the narrowing trend has been driven by product price declines greater than feedback costs, with the former reflecting in part some softening demand. A key issue now is the vulnerability for a squeeze on crack spreads. The degree of vulnerability will depend on the strength of demand into year-end.