Forget Omicron, it's inflation that is now the biggest threat to oil demand, or at least that is the oil market’s perception. Oil prices continue to be under pressure after the producer price index came in at a whopping 9.6% year-over-year, as well as a record-breaking 7.7% core rate.
That blow-out inflation number is raising fear that the Fed today will try to shock and awe the market out of these inflationary pressures that they helped create. Yet can the Fed keep a cool head after energy prices have already crashed, or will they signal an even more aggressive rate raising dot plot as well as a much quicker end to the taper?
If the Fed comes on too strong, the fear is that they will slow the economy and oil demand and give strength to the dollar. A rising dollar is also a negative for oil prices.
Economic data coming out of China is raising concerns about demand. The Wall Street Journal reported that China's leading indicators of consumption and investment activity weakened further from October, while factory production rose at a faster pace in November as a power crunch eased, according to China’s National Bureau of Statistics on Wednesday.
Industrial production expanded by 3.8% in November from a year ago, accelerating from 3.5% growth in October, a rare bright spot in China’s economy as efforts to alleviate electricity shortages led to increased coal output in recent weeks. A persistent property downturn continued to drag on overall investments. Consumer spending, a laggard in China’s recovery from the pandemic, also showed new signs of weakening.
The API reported that crude supply fell by 815.000 barrels. While that number was not as large as expected it should have included a 2 million barrel release from the Strategic Petroleum Reserve. The API also showed gasoline supplies increased slightly by 426,000 barrels but distillate inventories fell by 1.016 million barrels. Today the Energy Information Administration reports should be a bit more bullish than the API as the API was probably playing a bit of catch up; but we’ll have to wait and see.
We think from a big picture perspective the sell-off in oil is overdone. If the Fed comes off less hawkish than what the market thinks, we could be in for a big rebound in prices. On the other hand, if they come out more hawkish it does open up the trade for more downside.
It’s never a comfortable feeling when oil is hanging near key support which today should be around $69.00. A close below $69.00 could open up a sell-off towards the $65.00 a barrel area. A close back up above $73.00 could shift the market mood, but it doesn’t feel like it’s ready to do that just yet.
We still believe that the market has priced in a lot more demand destruction than is going to happen with Omicron fears and the Chinese slowdown. We expect that China will juice up their economy a little bit. I don’t think we’re going to miss too much of a beat on oil imports. China has been an active buyer of oil from OPEC and we expect that to continue.
From a geopolitical standpoint, things seem to be relatively calm. Vladimir Putin hasn’t decided to invade Ukraine just yet and it appears that Iran has made some type of deal with the International Atomic Energy Agency to allow weapons inspectors into the country. This is the first sign of real progress with the Iran talks even though they have a very long way to go.
Natural gas is still getting slammed on the lack of real winter weather. EBW Analytics on natural gas says that the January contract’s attempt to rebound above $4.00/MMBtu was quickly cut short by weather models reversing demand gains and very weak immediate-term physical demand.
By next week, however, steep spot demand gains and colder anomalies rolling forward into the 11-15 day outlook increase odds for another rebound attempt. Anemic immediate-term demand is likely to yield the first sizable storage surplus vs. the five-year average since April-with an emerging weather-driven surplus undercutting the likelihood for January to rise materially above $4.00. Late-winter contracts remain likely to continue lower in the medium-term, though stronger weather, fading production, and rising LNG may slow declines.