OPEC+ just rubberstamped the 648,000-barrel-per-day production increase for August, finally bringing back the 9.7-10 million barrels per day of oil that were first taken out of the market in April 2020 during the Covid collapse.
It took the Organization of the Petroleum Exporting Countries Plus two years to bring that oil back onto the market in dribs and drabs. It proved to be a great strategy for them, as they slowly released oil back onto a market that was fueled with a demand surge after the Covid lows, as global central banks pumped trillions of dollars in a matter of few months to get economies booming. This demand surge came in such a short time that, of course, prices had no choice other than to rally. Demand was too quick and too strong for the supply side to catch up. When demand is jacked up, and production is released slowly, with one third of the global producer capped at its knees (U.S. shale), it creates the perfect storm for prices to rise and inventories to drain. Today inventories are still at lows, with the U.S. strategic petroleum reserve withdrawal reaching emergency levels. Yet, the price of Brent oil is down by over 15% from its highs. Why is that?
Commodities are not about what level the inventories are today, but what level they will be at tomorrow. This is where most analysts get it wrong, as they assume demand is constant and assume the same linear extrapolation into the future -- calling for prices of $150-$200 per barrel. We know that that is never the case. It is always easy to forecast the supply, as projects take time to plan. Demand is dynamic and this is where we tend to get euphoric, "We are running out of oil!" calls on the way up. During the time OPEC+ was slow to release its oil onto the market -- hesitant to crush prices all together as demand was surging, given the stimulus boost. We also had a cold winter, with products depleted at a time Russia decided to invade Ukraine, halting access to more products. Fears of Russian oil getting lost forever were misplaced, as all that happened was that the oil found its way to new buyers, cheap opportunistic buyers. It was the trifecta of factors that helped prices reach way up.
The Fed is mostly to blame for this inflation. Given its Modern Monetary Theory experiment over the past decade, it has no choice but to find its way in all asset classes. With inflation now averaging close to 8%-10% year over year, the Fed now has no choice but to take its foot off the pedal and start draining the system of the same liquidity it pumped over the past few years. We are entering a slowdown, even a recession, as PMI and ISM are all indicating contraction across the board, as we come off our highs of the last year. Demand is slowing as the consumer is strapped. People are unable to spend more as housing, gas, and many goods have risen in cost way more than wages have -- leaving them with little extra money. These high prices will and are hitting demand, the same demand that analysts assume will never change just because it had been strong the previous quarter.
As demand falls, and supply has time to catch up, prices find the point of equilibrium at a lower level. OPEC+ knows this full well. For the group, to listen to President Biden's desperate pleas is pointless as it was never about how much oil OPEC+ was pumping, it just so happened that it was at a time when the world was short of products that caused a surge in product prices. Today, U.S. refineries are cranking out maximum gasoline and distillate at 93%-plus refining utilization to take advantage of these mouth-watering prices. Slowly and surely, inventories will start to build. It is just a matter of time.
Commodities are all about timing and if one focuses too much on the inventory picture today, then she will miss out on what is happening across the board as broader macro risk assets implode, suggesting a different story. This is all too reminiscent of 2008, where oil ignored the warning signs for three months, until it finally had to give in and collapse. Thanks Fed Powell for making it all just one big macro trade.