Supply and demand rule the commodities and oil have been rising on tight supply and increasing demand. Now the politicians are caught between a rock and hard place as on one hand they promise to cut carbon emissions but on the other, they need inflationary pressures to be relieved and that means lower energy prices.
Commodity Analysis - Oil
The next OPEC+ and JMMC meetings conclude tomorrow. As of now, the markets expect OPEC+ to raise monthly oil output by 400k b/d, with ministers from each nation all on board with the decision. Outside pressure from the Biden administration is pushing producers to increase production, but China's COVID situation and a decline in demand from the United States will be a cause for concern.
Last night’s US Private Energy Inventories from the American Petroleum Institute (API) show Crude: +3.594M v’s +2.2M expected Gasoline: -552K v’s -1.3M expected. Distillate: +573K V’s -1.4M expected. Cushing: -882K.
We will receive the weekly energy inventory report from the US Energy Information Administration (EIA) today, with an expectation of a draw on stocks from last week, showing an increase in demand. Brent and WTI prices will be put under pressure again should there be another upside built against expectations.
The US API data showed a drop in demand for oil from the USA, but the US State Department still decided oil producers like the UAE should increase production until the COVID-19 pandemic had a chance to resolve. I guess the rationale is that higher energy prices in 2021 divert money away from consumer spending, as people prioritize getting to work, but don’t necessarily have the means to buy non-essential goods. Nevertheless, we are seeing mounting evidence that oil production is currently less in demand and the chances are the price of oil could come down on decreased demand anyway.
Inflation costs are hitting consumers' pockets hard, so governments are concerned. Essential goods and durable goods are becoming more expensive due to the rising cost of energy, and transportation, which becomes a major drag on the economy and makes politicians unpopular.
As a result of the ongoing vaccine-led recovery, physical goods demand has reached such high levels that the global system has become increasingly constrained in terms of meeting the demand due to bottlenecks and supply chain disruptions. The measures of durable goods are now above pre-pandemic levels when looking across manufacturers’ new orders and PCE measures.
OPEC+'s apathetic production hikes are a key factor contributing to the acute physical supply constraints of Oil. OPEC members are hesitant to increase output beyond the agreed 400kb/d per month level. According to current plans, OPEC+ members will ease the pandemic-era output cuts in increments of 400k BPD per month until April 2022, with the overall curb pact extended through the end of 2022. OPEC+ members agreed to this in July.
Yesterday social media was in a tailspin after it was revealed OPEC+ has been underdelivering on its 400kb/d increase for several months as countries like Angola, Nigeria, and Azerbaijan have struggled to increase production due to technical, labor & investment challenges. As a result, the US must release inventories from its strategic reserves to cap rising prices. Biden went on the offensive last night, accusing Russia and Saudi Arabia of not increasing oil production which leads to higher inflation in things like energy prices.
In 2021, total world oil production levels are expected to be lower than in 2019, with a return to pre-pandemic levels expected for 2022. If oil markets remain tight for longer, oil inventories will decline, which is why oil markets have not collapsed back below $80 per barrel yet. OPEC's own monthly oil market report (MOMR) cut the 2021 demand growth forecast by 160k BPD and maintained the 2022 forecast at 4.2mln BPD.
Despite healthy oil demand assumptions going into the final quarter of this year, the downward revision was primarily driven by lower-than-expected actual data for the first three quarters of this year.
Obviously, OPEC+ would rather sell oil at a premium, so they are going to drag their heels when it comes to raising production levels, but they also must make sure that they are prepared for a larger drop in demand as China's increasing lockdowns are weighing on oil market sentiment.
There is a major transition going on in China right now, and it has been stated that it is experiencing an energy crisis as well. Chinese factories are suffering as indicated by the latest manufacturing activity survey, which dropped for the second consecutive month, possibly forcing the government to step in to help.
China's refiners are halting diesel exports amid tight domestic supply, and coal prices in the country have carved out a price chart that resembles the big dipper roller-coaster. There are reports across newswires stating that coal production in China grew 15% in October and exceeded power plant consumption for 25 consecutive days in October. If this turns out to be an underestimate the price of coal is likely to go no lower as we have seen a tiny bounce in recent days.
Currently, world leaders are discussing climate change at COP26, yet the largest polluter is China's coal-burning, and they aren't present.
According to companies like BP, global oil demand has rebounded above the key level of 100 million barrels per day last seen before the Covid-19 pandemic, which is in line with forecasts. Despite growing urgency to curb greenhouse gas emissions, fossil fuel consumption is recovering. Due to significant energy supply limitations, the resurgence is pushing prices to multiyear highs and damaging the global economic recovery.
As the oil industry returns to 100 million barrels a day, air travel is still recovering from the pandemic. Oil consumption has risen in the past two years as the demand for diesel and petrochemicals has risen, so getting to the net-zero promises being made by the world leaders is going to take a radical change in how we create and use energy. Until then oil and gas is the most efficient way to generate energy.
If we are back to the 100M BPD level and there is less oil being produced, the result is a global supply deficit of about 2.5 million barrels a day, according to Goldman Sachs Group Inc. which is another reason that oil is being supported above $80p/b.
Currently, Brent oil is up 88.8% over the last 12 months and that includes a 17% rise in the last quarter. The 6-month low and high are $85.42 and $63.07 respectively, which puts $74 the median price level over the last 6 months. With a tight market, there have been recent calls for $100 p/b prices, but I am not sure the politicians are going to let that happen.
One other factor that could cap oil prices is if Iranian oil makes its way back into the markets. Today there were reports of a US-led attempt to seize and extract oil from an Iranian ship in the Sea of Oman. But if there is to be a lifting of sanctions on Iran in the future this could tip the balance of supply exceeding demand.
The ActivTrades sentiment indicator is not giving anything away as the ratio of bulls and bears is 50:50. So considering the fundamentals outlined above are also mixed with some calling for a tight market but other data points detailing a fall in demand, I am going to rely on technology to show an opportunity. The H1 chart has a potential Head and Shoulders pattern and there is a case to be made for a break down towards the $74 level mentioned before, should the neckline give way to bearish pressure.
However, I am going to go with the continued tight market and rising demand through the winter narrative and wait for bearish oil traders to get stopped out. In my view, they are likely to get short on a break of $80 and leave their stop loss above the right shoulder of the chart pattern above and the $85 level. This is where I would like to see a long position initiated, targeting an acceleration higher to get back above the swing high or Head of the H&S pattern.