MigraineCall wrote: OK, I'll offer my views on it, from what I have learned, taking some time to look away from this sea of red today. We have negative China news dragging the markets down, and a long weekend holiday Monday where nobody wants to be long over the weekend. No surprise.
The oil traders I watch are bearish, but very cautious, ready to close shorts on an upward move. Kind of like picking up loonies in front of a steamroller.
I'll just ramble on here...
There are many moving parts to the oil business, and even the best models and minds and funds can never predict it reliably. Trading houses however, that can manilulate the market in certain directions when desired have the real power, and make billions moving it up and down, and even away from the fundamentals as it has been lately. The oil paper market is 10x the size of the physical market, with very little liquidity so it is easily pushed around. Lots of bull and bear traps. The snap back will be quick with the right trigger, and it has the potential for one heck of a short squeeze. In the meantime, we drop.
I used to think backwardation was bearish, but it's not. There should always be a normal backwardation amount in the futures curves to reflect interest, risk, and the costs of storing a commodity during the contract. Recently, the cost of the futures curve has changed as interest rates have gone up, shipping insurance and distances and tanker costs have increased due to Russian embargos, tanker storage costs have increased, as well as the future demand created when refilling the SPR putting a floor under the crude curve. Importantly for us, it is neccesary to look at recent changes to the slopes of the backwardation curves over a period of tiime, which have recently become flatter in the future, not more curved as you would think. Bullish.
As you mentioned, backwardation in the futures curves also causes a producer to realize less when hedging, which tend to limit decisions to increase production, meaning less oil coming to market in the future. Bullish.
This type of insurance is costly for a producer, and many producers want to quickly get out of debt as fast as possible to get away from this expensive forced hedging as per the stringent bank requirements needed to secure their loans. They can then benefit from and realize the full potential themselves, to gain the upside exposure of a healthy oil market environment.
Bullish for producers.
Weekly oil and product inventory data is imperfect, and chunky, depending on what day the data was recorded, however, it represents a good indicator of the supply demand balance, and therefore prices. Moving averages over timeframes are the better way to indicate trends. It is closely watched, and whether true or not, it moves the market. OPEC sets their policies and considers this data while determining output levels. The Chinese data is most opaque, as they try to hide their cards, allowing them to do things like buying Russian oil and gas, then selling it to Europe. The best Chinese data is derived form satellite, looking at the tank levels. Inventories of crude, products, and SPR the US are dropping. Certain products like diesel are in short supply globally.
Bullish.
AS for OPEC spare capacity, leaving Russia out of it for now, estimates that I believe most true are between 2 and 2.5 mmbpd sustained, the only producers able being SA, UAE, and Kuwait. The rest are at full capacity, cannot meet present quotas, and production is declining due to years of lack of investment. I do not see OPEC voting to increase production, and using up their last few bullets. With oil's retreat, I see a pause, or a slight change not enough to hurt a recovering global economy, but will imply they are still in control.
Some wild cards are:
Strengthening US Dollar
A rush to the USD makes WTI oil more expensive in other currencies. Meanwhile, a higher dollar drops commodities priced in USD like WTI. Higher US interest rates = higher dollar.
Iran, who has about 60 mmbbl floating oil in storage ready to hit the market, but can't grow production significantly in the near term as its main supplier Russia is also in an oil equipment sanctions pickle.
China: When will the zero Covid policy lockdowns stop? Before the October Chinese National Congress or after? Taiwan escalations. Further tit for tat east west economic roadblocks and challenges. Closer alignments with Russia and India and pushing further power influences on the region.
India: Loves buying cheap Russian and Iranian crude, refining it, and selling it to the global market as product, double ending the arbitrage. These are fantastic times to be a refiner there. They are very content with the status quo. They are also selling into their own markets, and demand is increasing at great rates along with most of the third world able to afford it.
Global Recession: Clearly this will reduce oil consumption, but will a demand drop exceed the shortfalls in production by how much?
Russian embargos Dec 5: Will Europe really decide to freeze in the dark and halt Russian oil?
Refinery shortfalls: China is a place where spare capacity still exists, however, they are taking control of teh teapot refiners in favour of state refineries. Will they start to consume crude and return products to the global market? In other places, the Diesel crack will offset reductions in gasoline crack, and favour heavier oil like Canadian crude where more diesel is realized. Light WTI just doesn't do the job for this.
Sh!tty Government: Have those in power in the US and Canada run out of stupid ideas yet? What is the next dumb thing they will do to delay the inevitable collapse of our energy system on the current path we are on? They have allowed the greens ESG protesters and rail blockaders to bring our countries to its knees, and strand our oil and gas assets as much as possible. Unfortunately there is nobody in the opposition that seems capable to step in and grab the wheel to divert it from the rocks. Sad.
Each day, a new headline hits, and the market reacts and tries to price it into oil. With the world in such bad shape today, I see that most headlines we get of doom and gloom will tend to have a negative influence on it. These times are very similar to those a couple years ago when the world was ending due to a pandemic. It didn't.
For me, as the markets drop, I'm going to take profits from the SQQQ Short, and buy more oily call options. With the drop in SU these last couple days, buying it for the divvy trade wasn't such a good trade after all. I will still hold, but am expecting further market negativity tomorrow as many exit positions prior to the Monday holiday long weekend.
Experienced has a good plan, and he also seems to think oil is near a bottom, sometime soon, and we are in agreement in that. Waiting for the turn is also a safe strategy.
Experienced wrote: I will be the first to defer to Migraine's expertise on the world energy market and the amount of research he puts into it. When I look at all this, I look at the big picture and the motivations of the big players involved. The stock market is as much phsycological as it is analytical and it is important to look at it that way when deciding what to do.
So - what do I see?
Oil Price Backwardation
In simple terms this means that the future price of oil is less than the current spot price. What does this mean? In essence it means that the big oil traders believe that there is a recession coming and the price of oil will fall because of that.
If they are right and there is a recession then the SP of all stocks will fall and because oil prices will fall, the SP of SU will go down from current levels.
Inventory Fluctuations of Oil
Oil traders have a lot to do with the level of oil inventories. Their decisions are based on a number of factors - the future price of oil compared to the current cost; storage costs and interest rates to name the main ones. With the oil market in backwardation and rising interest rates, it is difficult for oil traders to make the math work to buy oil today and make money by hedging through the purchase of oil futures. Similarly, oil producers, especially shale producers, are not able to hedge future production at higher prices than the current spot price and so provides a disincentive to produce more oil.
Backwardation has decreased in the last month but interest rates have gone up, so there is still an underlying pressure for oil traders to reduce stocks of oil and this puts downward pressure on oil prices. So merely looking at oil stocks and seeing levels going down does not necessarily mean that all is peachy keen. That said, since oil prices are now close to the Saudi full marginal cost of production (ie including social costs to keep the King in power), it is unlikely that backwardation will increase unless oil traders see a much worse recession than they predict now. Once the market shifts to Contango then the whole market dynamic is reversed.
OPEC Capacity
A recent IEA report shows that the sustainability of OPEC oil production is about 4 million barrels a day higher than the July production numbers. This means that if they chose to, OPEC could raise production to meet growing world demand. The key variable is if they chose to.
Current Oil Price
Months ago I posted that I predicted the energy price falling from over a 100 a barrel to the all-in marginal cost of Saudi oil production which is somewhere in the mid 80s. We are close to that level now. In a recession, the price may well fall below that levels but just like oil prices have fallen towards that marginal cost, if the price goes below that level there will be pressure for it to go back up. What this means is that now if a good time to buying oil stocks if you are a long term holder. If you are a short term holder then you may want to wait until the recession is in full swing.
So....What am I doing?
I continue to hold an underweight position in oil stocks and will opportunistically buy more on weakness especially in a recession scenario. If the recession takes the SP of oil stocks down to ridiculous levels, then I will overweight and sell the excess once prices recover.
I continue to have a full weight in pipelines and in electricity producers and will likely hold those positions at current weightings.