Cheers Everyone!

Well this week was filled with... nothing. Once again we chopped around aimlessly, with a bearish inventory build that happened yesterday. But, the inventory build was as expected as we go into summer driving season. I personally don't think we'll get our major upside movement until the May oil contract gets a roll. Currently, we are trading the March futures contract. To that point, we haven't seen a "consolidation" like this on the weekly chart since the early days of covid.

Big picture (Macro)

As you can see from the chart above, we have been continuously making higher lows and lower highs.. Aka, forming this nice big fat (bullish) wedge pattern. The fundamentals support the technicals. But when will it happen? Our guess is the April 3rd OPEC meeting. The crew at Gallatin have been pouring over countless hours of research and scenarios that could, would, and should happen. OPEC will keep current production the same going right into summer driving season. Giving us the pop we need to break over $85. To that point, come April 3rd, we will be trading the May futures contract. Funny how that works eh?

Fundamentals

Demand will exceed supply

Regarding the global oil balance, the Ukrainian crisis has put a wrench in the works. It created a forecasting nightmare and made it impossible to identify the potential source of the supply and demand imbalance. The market's erratic and occasionally violent behavior was a reflection of this uncertainty. Fears of a catastrophic supply constraint caused oil prices to surge over $139/bbl in the immediate aftermath of the invasion. Prices began to decline as tensions significantly subsided. They have actually been on a downward trajectory for the majority of the last eight months.

Concerns about inflation have been represented as the next dose of unpredictability. It was unclear how high interest rates may rise as central banks started to raise borrowing costs in a bid to control soaring consumer prices. The good news is that the settling process has begun. For instance, the front-month ICE Brent contract's current level of volatility is 26%. In the end of March in the previous year, it reached 90%. Following a rocky 2022, it is looking more and more likely that the world economy will avoid recession, interest rates will peak over the summer, and oil demand will soar while supply struggles to keep up with rising consumption.

In 2027, the IMF predicts that the global economy would grow by 3% to 4%. This projection is unmistakably a sign of rising oil demand. Its potential growth in the face of persistent economic prosperity is what is in dispute. Economic growth and oil demand growth are related; they are linked at the hip, as shown in the graph below. The indicator of greater demands for the black stuff is a thriving economy. We have a nearly unheard-of opportunity to measure this association thanks to the two sets of data's great correlation, which is 90% this century. We arrive at a demand increase of 380,000 bpd per year for every 1% increase in global growth after accounting for the anomalies of 2008 and 2020, when oil consumption declined disproportionately more quickly than the economic recession anticipated.

In the years 2024–2027, it predicts a steady yearly rise in the world's oil demand of between 1.17 and 1.27 million barrels per day. Based on the above comparison and the IEA's prediction that this year's oil consumption will average 101.90 mbpd, it is safe to anticipate that oil demand will steadily rise each year and could reach 105-106 mbpd by 2027. Demand is anticipated to continue to rise steadily in the near future, even in the unlikely scenario that renewable energy sources take some market share away from oil in the energy mix.

This increase is unlikely to be matched by an increase of equal magnitude on the supply side of the oil equation. The EIA provided a sneak glimpse of its previously released 2024 predictions. In 2024, non-OPEC supply growth will fall behind global demand growth by a sizable 940,000 bpd. The causes have received much of press. American shale producers prioritize shareholder returns over production growth and engage in share buybacks. The energy transition puts pressure on oil producers, particularly publicly traded businesses, to increase their investments in renewable energy at the price of oil exploration and production. Bank lending for new oil and gas fields is declining as a result of the same obstacle. There may be a gap between the amount of oil needed to meet global demand in the coming years and what is really available. And if this is the case, one cannot help but think that longer-dated oil is simply cheap given the backwardation of the two main crude oil futures contracts.

Reality Check

It was evident from the financial data for January that it would take longer than expected to stabilize inflation. It all began with the US nonfarm payrolls, which increased by 517,000 vs predictions of 185,000, and saw a decrease in the unemployment rate to 3.4%. Retail sales increased by 3%, exceeding estimates, showing that consumers have money to spend. It was crystal obvious from these two important monthly reports that US inflation has not been controlled. Consumer price growth slowed down less than anticipated, and producer price growth, which grew 6% on an annual basis, outperformed expectations. Those who were wagering that the Fed will start lowering interest rates this year now need to think again. The market's perspective is now more in line with the central bank's, to put it another way. That is, borrowing costs won't decrease this year, and peak interest rates will occur 2-3 months later than anticipated.

Even if it wasn't evident in the most recent oil balance report released last week, stubborn inflation increases concerns about weak oil demand. Both OPEC and the IEA increased their projections for global consumption. Notwithstanding this, oil prices significantly decreased, undoubtedly assisted by unfavorable supply developments. In March, Russian oil producers must maintain their current export rates. Despite the nation's promise to reduce production by 500,000 bpd, this is the case, which may be evidence that the EU embargo and the G7 price restriction are having an impact. Nigeria's output is said to have increased to 1.6 mbpd (it was 1.336 mbpd in January, secondary sources estimate). Next month, Kazakhstan will begin supplying Germany with 100,000 tonnes of crude oil through the Friendship pipeline, and between April and June, the US will release 26 million barrels of SPR oil (286,000 bpd). Indeed, there are concerning indicators on both the supply and demand sides. Although the market's response was justified, optimism should soon return to its previous levels. Since inflationary pressure is successfully being reduced and will eventually be lowered to the targeted level, this is an irrefutable reality. The current lack of measurable upside potential for oil will significantly decrease both producer and consumer prices. In a few months, the oil balance will become tighter, in part due to Russian sanctions. Brighter economic and demand forecasts mean that the downside is restricted as well, even though a sustained rally in stocks and oil does not appear likely.

So what's the deal?

The most important variable that determines the course that the global and regional economies take has been and will continue to be inflation. It is commonly acknowledged that success in the fight against it will be beneficial for expansion, but persistently high consumer and producer prices are anticipated to dampen investor optimism and may even trigger a recession. The consequences can be very negative. As it responds to shifts in economic growth, oil demand is not exempt from the inflationary effect.

Because of how important inflation is, even the discussion of interest rate increases or decreases has a significant and possibly disproportionate effect on the markets and can cause various asset prices to swing like a pendulum. The language of monetary policy makers is closely watched, and although using the word "entrenched" may result in a major flight to safe havens, merely the suggestion of the phrase "soft landing" will significantly increase the appetite for risk. The core issue is whether or not the inflation fight's profound effects on markets and the entire economy are justifiable. Does it really matter whether inflation is 2%, 5%, or 10% long as wage growth keeps pace with price growth? After all, if the number of goods and services that can be purchased with a certain monthly pay remain constant, the purchasing power does not decline, aggregate demand is still strong, and economic growth shouldn't be hampered. Yes, it does matter, is the quick response. That really does matter a lot.

First of all, inflation is a frequent occurrence. Data from the World Bank show that since 1981, prices have increased year, with the amount of the rise varying between 12% and 1.4%. Global inflationary pressure that lasts for a while is relatively inevitable. Consumer prices are increased by technological development and innovation, and global population expansion ensures that aggregate demand is always increasing. Although economies can profit from inflation, it all depends on how much prices rise.

The question is what would constitute a healthy rate of increase if we assume that prices will rise at the same rate they did in the past. Typically, central banks with monetary policy-making responsibilities are tasked with both increasing employment and preserving price stability. They all agree that an inflation rate of roughly 2% will help them reach their goals and is a necessary condition for strong economic growth, at least in industrialized economies. According to historical statistics, the economy may and does grow at a healthy rate when consumer prices increase by about 2% annually.

Low and stable inflation is advantageous to the whole economy. Due to potential house buyers' increased willingness to pay more for housing, homeowners will gradually see an increase in the value of their property. If inflation marginally exceeds the fixed rate, those who have fixed-rate debt, such as mortgages or student loans, will also discover that modest inflation benefits them. Investors will gain since the value of their investment will increase, and so will businesses that are in a position to raise prices in step with inflation.

On the other hand, extremely high inflation indicates financial danger. Milton Friedman described it as the outcome of "too much money pursuing too few commodities." It was undeniably the case that during the lockdowns connected to the pandemic, when significant savings were accumulated, prices significantly increased after the limitations were relaxed, causing an inflationary effect (the impact of which has been magnified by the Ukrainian war). Negative real interest rates occur from uncomfortably high inflation, eroding the value of savings. As the cost of living crisis worsens, it also results in rising borrowing costs and pressures governments to raise spending (see strikes in the UK and in France). Lower productivity could also result from rising labor expenses, but the most serious effect of high inflation is undoubtedly the uncertainty it fosters, which may show itself in a decline in capital investment.

Economic malaise with unpredictably negative effects would very surely result from persistently rising inflation and the deterioration of buying power. In order to avoid an unanticipated and catastrophic economic collapse, central banks are interfering in the economy in an effort to artificially restrain aggregate demand growth in a calculated and transparent manner, even if this results in a slower rate of growth or a temporary contraction. A global economic catastrophe, a recession, is being avoided thanks to the present cycle of monetary tightening. Although the recovery is undoubtedly difficult and its duration is currently simply unpredictable, recession, is being avoided.

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