The Bears Have It
The anticipated 2-weeks’ worth of EIA inventory data turned out not to be a pebble cast into a pond creating ripples, but an ocean landing meteor causing continued selling tsunamis, the waves of which keep washing up on both shores of the Atlantic as WTI and Brent mirrored each other and lost $3.76/barrel from the previous day’s settlement. More importantly from a technicians point of view, Heating Oil, the recent market stalwart, and Gasoil, both gave up their 200-day moving averages and the oil futures complex has unified into a bear market.
One can prescribe to all sorts of reasons and hindsight is a wonderful thing, for much of the news that has been brought to the dock of blame has already been in the market. The ceaseless record crude production from the US is established narrative and expansion in US crude stocks for the last 4-weeks with increases at the US storage hub of Cushing, Oklahoma by some 8% were Wednesday’s news as was the reduced refiner activity from China shown in October. However, the troubling house price index from China which yet again shrank by 0.1%, seemed to bring a market magnifying glass to all that could be deemed as demand and supply and reasons to be bullish were found wanting.
Oil prices have recently chimed with the wider macro-suite in having an inverse reaction to economic bad news, particularly from the US. Any measure or marker that offered a poor showing gave all markets cheer because of the inflation consequence allowing central banks to spare the world from rate rises. Yesterday, that appeared to reverse, at least for the day, as oil decoupled itself from said behaviour and bad news now is just that. As Brent contemplated $80, data from the US showed Jobless Claims rising slightly and Industrial Production shrinking 0.6% month-on-month versus a -0.3% call and a yearly figure of -0.7%. Poor numbers maybe, but not disastrous, however it was enough to tip the balance and carnage ensued with sell stops cascading with triggers.
Brent below $80/barrel is knife to the heart of any bullish sentiment and the longer it dwells there the more navel gazing oil participants will indulge in, for markets breathe confidence as oxygen and the air around oil has become thin. With Saudi Arabia and Russia’s influence on oil price currently side-lined, all eyes will look to the US as a lead particularly as Midland is gaining more influence on grade relationship pricing and how domestic inventory will influence its link with WTI. As we have for the last year, the US is where will find our drivers not only in oil, but how the inflation/interest rate wrangle plays out and the influence on financing commodity trading.
Core Inflation Rate (Oct) YoY Final
Restrictive finance will keep stocks low and price curves
The American financial tourists that stalk the halls of investment opportunity, swaddled by a frankly amazing US economy, have clearly showed their hands in recent weeks and months with what seems a perpetual and resolute mood to ignore any difficulty caused by higher interest rates and search through all manner of FED commentary in dovish pursuits. Unlike industrial commodities, pressured by poor global industry output and months and months of contraction in manufacturing PMIs, would-be equity market bulls are buoyed by data that represents individual behavioural trends such as retail sales, service sector expansion, personal expenditure and thriving employment. The ‘higher for longer’ mantra of central bankers seems to wash over such an attitude, which is why last week Federal Reserve Chair Jerome Powell was at pains to put right any sort of dovishness extracted after the FOMC decision and reverted to hammering home that high interest rates are here to stay.
However, recent price moves arguably represent in part that oil is not so immune to the clarion calls of Powell, Lagarde and their like. Pinning the tail of interest rates onto the donkey of a $20/barrel fall and blaming it solely, is disingenuous to say the least. The pendulum swing from over-exuberant Middle East conflict-buying cannot be overlooked, neither can the rapid rate at which refinery margin, however represented, gave away much value, and of course, the never-ending woe stories surround Chinese demand, be they from lower refinery runs or free-falling house price indices that have served proponents of triple digit crude very ill indeed.
Much of this fall from grace has been expressed in flat price having the obvious detrimental effect on spreads in general, but we now argue that interest rates are increasingly influential in oil structure planning as WTI flips into contango and drags Brent with it. Financing oil structure length and the problems faced with increased borrowing costs is not a new concept. What is, is the play out of ‘higher for longer’ and the influence it has on the cost of storage and indeed shipping. From 2009, banks were almost giving money away for free and during COVID there was more cash washing around the banking system than folk knew what to do with. But in these more stringent times, interest rates, in say the United States, have increased to over 5% and look set to stay there until at least the middle of 2024 despite the chomping-at-the-bit bulls described above.
During the described period of free money, those of the oil fraternity that engaged in moving or storing oil were able to commit to longer term strategies without having always to consider finance costs. Now value-at-risk (VAR) models are made more complicated and more punitive because of interest rate considerations. Putting oil into tank or pushing it around the world on VLCCs is hardly the stuff of day-trading and although this is not a new argument as to why some of the world’s destocking of oil has come about, as argued previously, it is the longevity of this investment hurdle that takes daily bites out of prospective ‘tank it and bank it thoughts’. Using a recent example provided by Bloomberg research, it opines, a 2-million-barrel cargo with prices at $80/barrel, based on an interest-rates at 5%, would cost $8 million per year in financing to hold onto the consignment. Putting a value in terms of spreads to this is a variable due to the circumstance or financial constraints exercised by different companies, but it would not be outlandish to suggest a consideration of 30c to 50c cost per barrel would be needed each month that the oil was held.
Stocks probably still stand in excess of 1-billion barrels in China, state owned tankage and oil need not worry about interest rates, yet. But oil storage is down in Europe, and nothing could be more interesting than the recent almost ‘bottoming’ at the US’s largest storage hub at Cushing, Oklahoma. Is it right to set this at the foot of interest rates and the influence on the financing of keeping oil? Only partially, but our point returns to that if interest rates continue in elevation the cost of owning and rolling length will remain prohibitive. Higher capital costs will continue to encourage de-stocking and the world might just have to get used to having less oil in tank to rely on. Naturally, contango markets will bring back front to back buyers, but the value of the discount of a nearby month as opposed to a forward one would have to be very negative to compensate for borrowing costs. The other risk in destocking is that with a hand-to-mouth oil market, any great geopolitical event will cause an outsize rally and massive spread buying, no matter the cost. We await to see how this consideration in time value of money plays out and whether our caution has merit.
17 Nov 2023