Brent crude rallied to nearly $80 a barrel last week from the low $70s in mid-August. As we approach the OPEC meeting this Sunday, Sept. 23, in Algiers, we will start to see and hear more commentary about the supply cuts in place and the agreement that was set in June to raise output, or to cement what already had been decided prior to the meeting.
Hedge funds are long oil and the International Energy Agency (IEA) and other oil pundits are calling for higher prices, worried about Iran sanctions kicking in properly on Nov. 2. The million-dollar question on everyone's mind, outside of President Trump given he would like a lower price going into midterm elections, is, "Where will oil be in October?"
When trading oil, most generalists track OPEC commentary, geopolitics, IEA calls for demand/supply balances and Trump commentary. No one other than pure oil traders look at gasoline and distillate balances, refinery utilization and, last but not the least, seasonality.
Seasonality is one of the biggest drivers of oil and yet is known to few. I find the broader OPEC commentary as nothing more than mere noise, as what they do and say are two entirely different things. June was a good example of that dichotomy as Russia and Saudi Arabia decided to start raising production in June prior to the meeting, only to announce at the end that it was done, with rest of OPEC really not having a choice. OPEC is really SauRuUS.
May through September is the key summer driving season where demand for gasoline drives demand for crude. We are nearing the end of that season, but hurricanes are still a force to be reckoned with. This is the time when most hurricanes hit the Atlantic and Gulf coasts and potentially can cause significant damage to infrastructure. These storms need to be monitored as they can take capacity out for a short time.
Hurricane Florence was the latest storm where the trajectory was headed toward the East Coast and caused many refineries to evacuate personnel. As of Monday, Florence was a post-tropical cyclone with sustained winds of 25 mph. There is still heavy rainfall and it is expected to affect electrical power in the Southeast for weeks.
Hurricane Isaac is still on the horizon but has a low chance of redeveloping in the Caribbean. Officially the peak of hurricane season occurs around end of September. One must monitor the amount of capacity that has been taken off line as it can distort the supply/demand picture in the very short term. If any storm hits a key refinery or pipeline there is a risk of spikes in oil prices, hence oil never falls in September. There is a risk premium that currently is embedded into the price outside of fundamentals.
As for the fundamentals, last week's Department of Energy (DOE) inventory data painted a very dire picture that was lost in all the other headlines. Given lucrative refining margins, U.S. refineries have been cranking up production of gasoline and distillate (record levels of input for this time of year) to capitalize on these margins. Demand has been flat, so gasoline inventories have been picking up significantly and now are above last year's levels.
Distillate, which is a by-product of gasoline production, last week neared a seasonal record of 5.536 million barrels per day. U.S. refiners are rebuilding depleted inventories from earlier this year. Distillate was tight fundamentally but now is nearing average levels for this time of year; the deficit is gone. Into the second half of 2018 and into the key winter heating season, distillate is what will drive the oil market. This is the reason why oil prices were so well-supported at the start of the year. Given prospects for a very comfortable market, not to mention prospects of demand softening on back of the emerging market and global demand collapse as witnessed in the economic data last month, oil demand risks are to the downside.
Oil production in August has risen to a 2018 high as Libya and Iraq recovered, offsetting the cut in Iran's exports. OPEC pumped 32.79 million barrels per day in August, up 220,000 barrels per day from the revised July figure (the highest this year). We are at 120% compliance following the June agreement, which is over-producing.
Russia's output stood at 11.21 million barrels per day, unchanged from July and at record highs still. Russian Energy Minister Alexander Novak last week said his country could raise output by 300,000 barrels per day should the market require it. Any loss of Iranian barrels can be met by OPEC or Russia. Consequently, there is more oil to come at a time when demand is showing signs of slowing down. Even if no further output hits the market, there should be less demand to soak up the current supply and prices should be lower.
Once hurricane season is over, there will be little to prop up the price of oil, barring any significant capacity taken out over the next few weeks.