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/1 This thread will highlight the outsize role of Strategic Petroleum Reserve (SPR) barrels in EIA #oil inventory data; the misunderstood time lag of #OPEC cuts/surges; & why I expect higher oil prices in 12 weeks. #OOTT #EFT #Oilprices (cont’d)
On Nov 30th, 2016, OPEC surprised many market watchers (not me) by announcing a Production Cut. For those fortunate enough to be holding energy equities into the Meeting, the next month was extremely favorable for returns, as TI moved from upper 40s to 55. The cuts were to begin
Jan 1st, ‘17. By mid-March ‘17, however, something unexpected happened. Rather than the OPEC cuts draining US inventories, EIA data began to show large crude builds for many successive wks. The corresponding negative impact on TI prices & equities was dramatic. Investors began to
question whether OPEC was actually cutting, whether any cuts would matter if implemented, & whether OPEC was in fact “dead.” What had happened? Two things. First, in Dec. ‘16, before the cuts began, OPEC pumped & exported more barrels in the run-up to Jan. 1st. I call this the
“Mardi Gras” effect. That is, a period of binging (extra bbls pumped/exported) before penance (supply cuts). The problem w/ this strategy is that the TIME LAG between barrels being shipped from Saudi & arriving in the Houston Ship Channel (44 days) means that the data are always
Wks behind OPEC actions. So that if you pump extra in Dec. ‘16, then begin cutting in Jan. ‘17, EIA data will be negatively impacted by the extra Dec barrels *after* the Jan 1st cuts have technically started. This confused the market. Worse, the extra barrels arrived in the
Run-up to a major policy shift in the US: “Planned Sales” of SPR oil. Beginning in spring ‘17, DOE commenced a congressionally-mandated, bi-annual program of selling oil out of the SPR. The ostensible benefit of this program is budgetary. In reality, though, the
SPR sales have had a deleterious effect on not only the price of crude but also the stability of the broader market & domestic producers. In fact, I would argue that the “planned” SPR sales have done as much to debilitate the US shale industry the past few years (by negatively
skewing EIA inventory data & market sentiment) as any other factor. Let’s go back to March ‘17. In mid-March, TI begins to slide as investors become impatient over OPEC cuts. Then refinery maintenance further dampens demand. And THEN you have SPR barrels come out of storage and
maul TI prices. Between Feb & June, oil falls from mid-50s to $42. Energy equities get hammered. The optimism of the OPEC cuts is eroded. It ultimately takes the impact & aftermath of Hurricane Harvey months later to “jumble” the EIA products data & finally get investors to
believe that the Production Cuts have started to work. Tellingly, fall of ‘17, when the cuts *finally* materialized in EIA data, is the only time in past three years that the period encompassing planned SPR releases has failed to drive down crude. The other 5 SPR-release periods
from March ‘17-fall ‘19 have been crushing for crude. There’s no getting around it: releasing SPR barrels has a direct & negative impact on oil prices, esp. given that the barrels are released during spring/fall refinery maintenance. I am NOT making a political comment; I’m
simply observing that bringing bbls out of inventory has been consistently shown to depress prices. In essence, the SPR releases have created a twice-yearly “speed bump” for crude prices & dramatically undercut upside potential. Draw your own conclusions about Govt intent.
Second example. In late Sept. 2018, crude prices had reached the mid-70s. Lengthy OPEC cuts (from prior year) had apparently done the trick. Talk began to percolate of $100 oil. IEA director Biriol warned of a “red line” that supply was approaching, & urged producers to pump more
Then something unexpected happened again. Rather than march toward $100, crude collapsed in spectacular fashion, dropping from $76 to $42 in short order, destroying equities & energy-focused hedge funds alike in a period of less than 8 wks. What happened? The same toxic mix of:
Extra OPEC barrels (KSA), refinery maintenance (fall), & barrels coming out of the SPR. Saudi, at the behest of Pres. Trump, had begun to pump more in the run-up to anticipated sanctions on Iran (to begin in early Nov. ‘18). Again, the TIME LAG between KSA pumping more and those
barrels hitting Houston meant that over summer ‘18 oil prices continued to rise, b/c KSA “surge” bbls had not yet impacted data. When Trump surprised the market by announcing sanctions waivers, it was too late, as the KSA bbls were already en route. When they hit Houston the
extra KSA barrels compounded the effect of barrels coming out of the SPR, at the worst conceivable time—fall refinery maintenance—and the result was *literally* the worst month for energy equities in history (Dec. ‘18).
Flash forward to the present. The past two months,
Flash forward to the present. The past two months,
something unexpected has happened (again). The price of oil has risen far more than most (myself included) had anticipated after the negative price debacle. Energy equities have caught a bid. Most important, EIA data has been “less bad” than expected. WHY? The impact of the SPR,
but in *reverse*. In April, DOE began leasing space in the SPR to 9 producers, contracting for a total of 23.2 mm bbls to be stored. Removing commercial bbls each wk has had the direct effect of “cushioning” EIA data by making the nameplate builds appear smaller. Since April,
over 16 mm bbls have been diverted out of commercial stocks & into the SPR. Traders should obviously break out the SPR factor each wk; but they’re lazy & the the headline stock change # tends to prevail. This has contributed to a furious rally for oil the past 8 wks, despite 1)
Terrible cracks 2) Subdued demand 3) Extra OPEC bbls. Candidly, it’s insane TI is $40 today. But WAIT. Largest production cuts in history are about to hit directly on heels of SPR bbls going INTO storage, as opposed to being released. Even if you model only small improvement in
demand over the next 10 wks, EIA data could *still* show large draws beginning in 2nd half July-Sept. Combined impact of cuts, plus base declines, could more than offset shut-ins/DUCs returning. If so, TI is priced wrong, & will need to be higher by fall. That’s my Base Case for
