Sometimes you must follow hedgers to get an idea of potential upside risk in a market. Hedging activity in the products surged to year highs because the major players can’t afford to be complacent in a world where the risk of a major price spike is at the highest level it has been in a generation. Oh sure, the speculators can put the war premium in and take the war premium out but if your company knows that a price spike could put them out of business, it would be almost a dereliction of duty not to take some protection.
Major hedgers are not convinced that despite the recent reduction of oil price risk premium, the potential for a major price spike in the market is gone. Based on recent hedging activity they realize that the war risk to supply is not over but maybe just getting started. Major fuel users such as airlines and manufacturers have taken advantage of the recent price drops to get insurance against the greatest risk to supply in years. And they should. Bloomberg reports that,
“Lufthansa, IAG are among companies that have higher hedge levels and Air France says it’s boosting protection for the first quarter. I am also hearing of other end users that are beefing up their hedges".
Already war or no war, the markets look to be undersupplied by at least 2 million barrels of oil a day in the new year. And even though the oil supply has not been disrupted to this point, to assume it will not be is wishful thinking.
Even as Secretary of State Antony Blinken asks Israel for a pause in the war in Gaza the world dangers are not going away.
Overnight Reuters reports that,
“The United Arab Emirates warned on Friday that there was a risk of a regional spillover from the Israel-Hamas war in Gaza, adding that it was working “relentlessly” to secure a humanitarian ceasefire."
They reported that, “Russia launched a massive drone attack early on Friday, hitting critical infrastructure in the west and south of Ukraine and destroying private houses and commercial buildings in Kharkiv, Ukraine’s second-largest city, officials said. We saw Iran-backed Houthi rebels in Yemen have launched rockets and drones at Israel, while Saudi Arabia’s military is also clashing with the militant group according to Bloomberg.
OPEC Plus is already signaling that they will extend their oil production cuts into the new year. Even if they did not have the spare capacity that they have, would be exhausted if they decided to change course.
We saw that in the rebound in the crack spreads as the ultra-low sulfur heating crack soared this week even as oil pulled back. Both the gasoline and distillate crack spreads were declining due to seasonality and recession fears, but that looks to change as the haven is bought by end users as well and the fact that the Fed is signaling that the rate hiking cycle may have ended is giving the market a much more bullish outlook. That provides underlying strength in the oil market and technically because oil was so oversold it makes it much more dangerous to be short.
If you look at the monthly charts on oil, the potential for a move to $111 a barrel is real but obviously to get to that level it will take some disruption. Yet to dismiss the possibility of an oil price disruption is probably not advisable. And even if we don’t get the spike to triple-digit oil the possibility for a solid rally to get back up to $90 is a real possibility. In the big picture, we think from these price levels the downside risk is limited but the upside potential is much more open-ended.
Of course, we have been warning about upside price risks since oil was in the 60s this year even as many tried to say that Chinese oil demand and a recession would keep prices lower. We warned of upside price risk for gasoline and diesel that happened with a vengeance. That is why I am continuing to warn people not to be fooled by the recent price pullback. Be safe rather than sorry and while we may not get the mother of all price spikes, that risk is still there. That’s why they are desperately seeking safety.
There is also growing pressure on the Biden administration to stop codling regimes like Iran and Venezuela. One of the most strategic and moral blunders by the Biden team was to try to allow Iran to sell oil even though they knew that that money would go to fund Hamas Hezbollah and the Houthis. Their desperation to get their hands on heavy Venezuelan oil has also backfired after Venezuela has already reneged on its pledge to hold a ‘fair and free’ election.
Yet China is making its move. Reuters is reporting that, “China’s PetroChina is proposing to buy up to 8 million barrels a month of Venezuelan crude from state-run oil company PDVSA, according to four people familiar with the matter, hoping to resume a trade suspended four years ago by U.S. sanctions.
Yet while this administration seemingly allows these regimes to prosper by selling oil they continue to stymie the US oil and gas sector. Fox Business’s Thomas Catenacci writes that, “The Biden administration announced Thursday that it would indefinitely postpone a major oil and gas lease sale mandated by the Inflation Reduction Act (IRA) pending an upcoming court decision. The Department of the Interior’s Bureau of Ocean Energy Management (BOEM) explained that it would delay Lease Sale 261 — which is set to span nearly 73 million acres across the Gulf of Mexico — as a result of legal uncertainty. Under the IRA, BOEM was ordered to hold the sale by the end of September, but it became the subject of litigation after the agency added last-minute environmental restrictions.
Europe’s green energy obsession left them more dependent on Russia for supply and now they just can’t quit them! Price caps for oil have failed and as Europe has been forced back into using more fossil fuel it has been a boom for US coal producers. The EIA reports that, “EU sanctions on Russia’s coal increase U.S. coal exports to Europe monthly U.S. coal exports. U.S. coal exports increased by 5.7 million short tons (MMst) in the 12 months after EU sanctions on coal from Russia went into full effect in August 2022. The increase was driven almost exclusively by a 22% jump in U.S. coal exports to Europe, totaling 33.1 MMst between August 2022 and July 2023 compared with 27.1 MMst during the same period before the sanctions (August 2021–July 2022). In 2021, Europe received 84.6 MMst of coal from Russia, about one-third of Russia’s total exports.
After Russia’s full-scale invasion of Ukraine in February 2022, the EU responded by imposing sanctions on coal from Russia in April 2022, with a grace period for pre-existing contracts that lasted until August 2022. Once a ban on European buyers purchasing coal from Russia went into full effect in early August 2022, imports of coal from Russia into Europe fell to almost nothing. The United States joined other coal-supplying countries, including South Africa and Colombia, to make up the difference. U.S. coal exports also increased to Asia and South America but declined in Africa, Australia and Oceania, and North America.
Natural gas shook off an early weather-related sell-off and rebounded after a report from the EIA. They said working gas in storage was 3,779 Bcf as of Friday, October 27, 2023, according to EIA estimates. This represents a net increase of 79 Bcf from the previous week. Stocks were 293 Bcf higher than last year at this time and 205 Bcf above the five-year average of 3,574 Bcf. At 3,779 Bcf, the total working gas is within the five-year historical range.