The long oil call has been the most covered story since the Russian invasion of Ukraine. Calls of oil heading to $150 to $200 were echoed across trading floors when the Russians walked into Ukraine as the market grew worried that all 10 mbpd of Russian oil would be lost forever from the market as the rest of the world put sanctions to limit Russia's reach.
It was being punished by the Big Brother (aka, the western world) for daring to breach peace treaties that have been in place for decades. Low and behold as the weeks carried on the world realized that other than the US and its allies, the rest of the world cared more about their economy's trade balance than respecting historical geographical boundaries.
As China and India soaked in the cheap Russian barrels, it became apparent that the Russian oil would not be lost, it was just getting re-routed as the global alliances were shifting.
There has been a secular theme to the oil markets since the start of the year. Inventories across key products like gasoline and distillate along with OECD crude inventories have been depleting, trading at lows for this time of year and especially vs. their five-year average.
The US Strategic Petroleum Reserve has come in handy offloading barrels each week that has helped in compensating for the lost OECD barrels, but the concern now grows that the US itself is getting "low" on oil. Yet the oil prices are unable to stage a recovery despite these bullish shrieks of how the world is running out of oil.
Supply and Demand
The oil market is not only about supply but it is also about demand. Demand has been unusually weak for this time of the year as seen by the four-week moving average data reported week on week. Gasoline demand is below pre-Covid levels and well below most summer seasonal norms. US consumers are paying attention to their discretionary spending as they save their disposable income to pay for their gas, electricity and housing bills that have doubled if not quadrupled.
The manufacturing slowdown is hitting distillate demand. This is all adding up as we are now seeing inventories slowly build over the past few weeks. Prices fell 40% from the middle of June, and the data is only now reflecting it. The market prices in what is being felt today not what will happen tomorrow. Prices move first and then the data follows.
There are some commodity markets that may be better positioned from a demand/supply balance point of view, but even they are not rallying to new highs. Commodities can no longer be looked at in isolation as it is not just about the bottoms up story. It is also about the global macroeconomic cycle and that is showing consistent weakness with global central banks unable to help their investors as this time inflation is just too high for them to print their way out of it. They are more than aware what happened back in the 70s and 80s, and want to avoid that outcome now.
The Fed's Powell spoke at the FOMC yesterday and reiterated the Fed's desire to keep raising rates to get inflation back down to their 2% goal. Desperate cries of the Fed being close to a pivot are used to justify a rally, which gets washed away each time they see the Fed is unwilling to budge.
The Fed is playing a very dangerous game here, but the bond markets have blinked and spreads have inverted the most since the 1980s and these levels are associated with past financial crises. The Fed keeps saying they will be able to engineer a soft landing, just like they thought inflation was "transitory" after boosting the economy with trillions of dollars in a few months. Of course, we believe them.