What Are The Bear Forces Right Now For The Oil Market?

What Are The Bear Forces Right Now For The Oil Market?

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Global oil inventories are headed down, oil prices are over $100/bbl, so it’s more important than ever now to ask the serious questions: what are the bear forces we need to watch for right now?

On Jan 9, I wrote a WCTW titled, “Post-Mortem.” At the time, here are the things I said that could ruin our energy thesis in 2022:

  1. Global oil demand.
  2. Global ex-OPEC, US production decline rate (or e.g. supplies).
  3. US shale production growth.

Fast-forwarding to today, these 3 variables are still the key drivers of the oil market, but with a new twist. With Russia’s invasion of Ukraine, global ex-OPEC, US production is now skewed to the downside. Even in the scenario of a minimal decline in Russia’s oil production/crude exports, the risk is not to the upside, and as a result, this is no longer a “downside” risk factor.

Instead, we can just focus on global oil demand and US shale production growth. Let’s tackle the demand variable last, so let’s first visit US shale production. As frac spread counts rose throughout the year, we have revised up US oil production exit from 12.2 – 12.3 million b/d to 12.4 to 12.5 million b/d. We fully expect capex to increase in May/June when companies report 1st quarter earnings. This capex raise is likely on the back of servicing cost inflation, and companies will likely increase capex slightly higher to reflect minor exit production growth for 2023. As a result, we see a bump higher in exit production, but the increase will be tame.

Looking at US oil production so far YTD, it is flat, so there’s no massive ramp-up like what we saw throughout 2017 and 2018.

US oil production

HFIR

Now turning over to oil demand, there are some signs of fatigue, but nothing that warrants extra precaution. For starters, oil futures are currently trading down at the moment thanks to the Shanghai COVID lockdown. The problem going forward for oil bulls is that if China continues its zero COVID policy, there will likely be more lockdowns ahead. This is the same for other Asian countries that have yet to realize that herd immunity is the only way to fend off COVID. For every country that has adopted strict COVID lockdown policies, the end result is a spike in the case of counts regardless of vaccination rates.

At this point, if you still believe lockdowns work, then you are just delusional. But the problem for oil bulls and oil demand is that as these Asian countries start to reopen, COVID cases are likely to increase prompting exaggerated government response. While the landscape is early, it is a possibility that COVID-related lockdowns may occur, and some non-OECD oil demand figures will be impacted.

While this may help keep oil prices from spiking well above $125 in the near term, it only delays the inevitable. Once these governments realize that COVID lockdowns don’t work, the demand will have a trampoline-like rebound, sending prices even higher down the road.

For now though, if China continues the zero COVID policy, this is a risk to oil demand, and something we need to keep a close eye on.

As for the rest of the global economy, copper prices are doing ok, but not great. You can see that copper did attempt to break out to a new high only to pull back. Depending on where this goes over the next few months, it will be telling where the global economy is headed.

Copper

StockCharts.com

In addition, the copper to gold ratio has started to stall, indicating growth momentum may be peaking.

copper to gold

StockCharts.com

And the really worrying chart as of late is the inverse dollar to WTI:

Inverse USD vs WTI

StockCharts.com

As you can see, we are now seeing one of the largest divergences in history between the dollar and WTI. The combination of a strengthening dollar and higher oil will hit emerging economies hard. So it’s more important than ever to keep a close eye on all the global economic figures.

But nothing is better than keeping track of oil demand than the data itself:

Demand

EIA, HFIR

Total liquids

EIA, HFIR

And as of right now, implied oil demand is holding up well, and global oil inventories (with the US being the most visible) are still drawing.

Again, while things continue to be in favor of the oil bulls, we need to stay vigilant on all the demand variables.

Other Possible Bear Forces

JCPOA, Iran deal is largely expected by the market now. In the event of a deal, 70 to 80 million bbls of floating storage (crude and condensate) will be made available to the market. Backwardation in Brent will drop causing more hedge funds to liquidate. This is a bearish factor.

More SPR releases from the US and IEA are possible, but as we wrote over the weekend, the market is starting to overlook the SPR releases knowing full well the governments have to buy them back later.

Conclusion

Global oil inventories are low, supplies are in check, and geopolitical risks are high. While the oil bulls have the tailwind behind their backs, we need to stay vigilant and watch for signs of faltering demand. We are constantly watching out for all the variables, but these are the bearish forces on the market today.

Originally Posted on: https://seekingalpha.com/article/4498544-what-are-the-bear-forces-right-now-for-the-oil-market?source=feed_tag_commodities
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