You don’t have to worry about oil fundamentals. You just have to worry about the dollar’s value, which is a very safe way to look at the market until it isn’t. What are the biggest threats to the global economy? Maybe when the price of commodities decouples from the value of the currencies and focuses instead on the relative tightness of supply.
Forget about supply and demand and the fact that when China opens, the world will be undersupplied in oil. You can forget about the fact that Russia is now calling for OPEC to cut production at the next OPEC meeting on October 5th by a million barrels a day. We can forget the fact that global oil inventories are at severe risk; not only are they undersupplied, but because of the war in Ukraine, the attacks on the Nord stream one and Nord stream two pipelines, the risk of a supply cut-off this winter is extremely high. You can pray again about the fact that Exxon Mobil (NYSE:XOM) is rationing supply to France. The headline reads that Exxon Mobil is temporarily limiting French refined oil products to French customers.
The talk of alleged sabotage on the Nord stream one and Nord Stream 2 pipelines is swirling with a lot of speculation as to whether it was sabotage or not, at least according to Secretary of State Anthony Blinken. But it’s obvious that the coincidence is just too high for it not to be some type of sabotage. The problem is to determine who did it. Some people say it’s Russia trying to send a message to the world that they could cut off supplies. Others’ thoughts are more nefarious and think it’s a Ukrainian or a CIA operation to point fingers at Russia to increase the resolve of the EU and Germany against Russia. I do not want to go down the rabbit hole, and I believe that an investigation should be completed, but at the same time, it does appear to strengthen the resolve of the EU against Russia.
The Guardian reported that European commission president Ursula Von der Leyen said the leaks were due to “sabotage” and threatened the “strongest possible response” to any deliberate disruption of European energy infrastructure.
She warned while urging an investigation to get full clarity on the “events and why”:
“Any deliberate disruption of active European energy infrastructure is unacceptable and will lead to the strongest possible response.”
Bloomberg reported that natural gas prices in Europe surged after Russia said it might cut off supplies via Ukraine, and the German Navy was deployed to investigate the suspected sabotage of the Nord Stream pipelines. Putin moved to annex a large chunk of Ukrainian territory amid a string of military setbacks in its seven-month-old invasion. The reason why we can ignore all that stuff is that the market is focused on the broader macroeconomic picture.
Oil prices plunged when the 10-year treasury note touched above 4% in European trading, and the Chinese currency hit an all-time low against the dollar. The Wall Street Journal reported that the 10-year note had climbed 2.5 percentage points this year, the largest increase since 1981.
Despite attempts at intervention, the Wall Street Journal reported that the offshore Chinese yuan depreciated to more than 7.2 to the dollar for the first time since a separate system for trading the currency outside mainland China was launched more than a decade ago. By afternoon trading in Hong Kong, the offshore yuan was trading at about 7.2560 per dollar, according to FactSet. That caps a fall of about 12% for the yuan, also known as the renminbi, against the greenback this year.
Yet despite the currency issues and economic issues in China, reports are saying that China’s refineries are getting optimistic and getting ready for a big surge in demand. Reuters is reporting at least three Chinese state oil refineries, and a privately run mega refiner are considering increasing runs by up to 10% in October from September, eyeing stronger demand and a possible surge in fourth-quarter fuel exports, people with knowledge of the matter said. Chinese refiners are expecting Beijing to release up to 15 million tonnes worth of oil products export quotas for the rest of the year to support the no. 2 economy’s sagging exports. Such a move would signal a reversal in China’s oil products export policy, add to global supplies and depress fuel prices.
The API report showed crude supply up 4.15 million barrels. API showed that the gasoline stocks were down 1.048 million barrels, and the distillate stocks were 438,000 barrels. The API report was supportive but not as bullish as the whisper number would have us believe. If you look at the crude build on face value, we see that the 4.15 million barrel bill came with help from the Strategic Petroleum Reserve of a 4.5 million barrel release. With OPEC talking about cutting production by a million barrels a day and the possibility that the SPR releases will stop, the odds are that we are going to continue to be in an oil deficit, especially when demand picks up this winter.
The pipeline sabotage also supported diesel prices in the U.S. natural gas. Shortages will lead to fuel switching to oil and an attempt to import more liquefied natural gas. At the same time, products were supported by a rash of refinery outages. BP (NYSE:BP) reported that the fire in their Toledo refinery may take until 2023 to come back online.
You can’t fight the Fed, nor can you fight the dollar, but that doesn’t mean that the oil and the dollar are going to stay as correlated as they have been during the last couple of weeks. The biggest fear is what will happen when oil decouples from the dollar and how that can happen is when the market realizes it is undersupplied. Obviously, if the economy acts as bad as the market suggests, it could perhaps drop, and demand could offset the looming supply shortages. But it would have to be a dramatic drop in demand because right now, we are facing a supply deficit this winter. Without a substantial demand drop, we will continue to see the risk of price spikes.
Natural gas still has some technical weaknesses due to some short-term weather situations. Let’s pray for the people in the path of Hurricane Ian. While the impact on energy infrastructure is expected to be minimal, the impact on people’s lives could be dramatic.