Cheers Everyone!

Long time no talk! Why? Because we've been in the same range (as expected) for the last 3 months since we called the "bottom" in this downtrend. Why the newsletter now? Markets do one of two things, they consolidate and they expand. As you can guess, we have been in the consolidating phase BUT we are gearing up for a massive move.

Big picture (Macro)

As you can see, all of our micro targets have been hit and we've tested our line in the sand support twice now. Todays newsletter will be fairly long as we will dive into the fundamentals of why we've been chopping around for the last 3 months and what we expect the next move is for the next few months.

This quarter will be the time to survive for the bulls as we head into the summer travel season. The most bullish time of them all for oil prices. In the last few newsletters I've gone through the tailwinds (underinvestment in capex within the last 10 years, the lack of publicly traded banking investments, our current presidential administration thinking we don't need oil after the next 5 years, the lack of A+ spud locations available , the rapid destruction of DUC's) and the headwinds (uncertainty in plane travel by emerging markets and China). Notice how I only have one head wind? It's not a coincidence... 

Todays newsletter will be a tad bit long, but I do hope you enjoy the read as we take a deep dive into the fundamentals. If you would like to subscribe for free on how we trade the markets every single day, we give our entire play EVERY SINGLE DAY in the newsletter below. Just click the button to subscribe.

Fundamentals

CPI & EIA

It didn't take long for investors to comprehend and disregard Tuesday's US CPI data, which, while slowing, was higher than expected - both headline and core inflation. The focus switched to retail sales in the United States. In January, it increased by 3%, exceeding expectations. The market's reaction was understandable, albeit perhaps premature. The major US equity indices concluded the day in the green. Investors appear to be perennially hopeful about successfully mitigating the impact of inflation, but stock market gains are likely to be capped unless there are unanimous signals of interest rates topping.

The weekly EIA numbers drove a frantic day for oil. Commercial oil stocks in the United States increased for the sixth week in a row. The weekly increase was 19 million barrels, taking inventories above the 5-year average for the first time in nearly two years. The increase in crude oil stocks of 16 million barrels drove the build (14 million bbls of which took place in PADD 3). The ongoing refinery maintenance could explain the massive construction, but the numbers remain difficult to reconcile. Refiners decreased rates by 1.4% (-400,000 bpd), net crude oil imports fell, while domestic output remained resilient at 12.3 mbpd - these figures do not add up to 16 million barrels.

The EIA's "adjustment factor" is a more likely explanation for the massive crude oil build. This weekly balancing act stems from the fact that, while the EIA gathers as many weekly data as feasible, estimates are employed for figures that are not available on a regular basis. After monthly data is available, these projections are re-evaluated. The massive crude oil gain last week was caused by a weekly upward adjustment of 1.967 mbpd in the crude oil balance, which followed a downward revision of 702,000 bpd the prior week. These imply that imports and/or production were understated. When it became clear that the "adjustment factor" was to blame for the mega-project, the initial sell-off changed into a buying frenzy, driving prices well beyond the day's lows. This morning, follow-through buying adds additional support; nevertheless, the projected oil balance for the first half of 2023 should dampen enthusiasm about any immediate and lasting price gain, with considerably improved prospects in the second half of the year.

OPEC demand outlook

One of the important implications from the revised set of monthly oil balance statistics is that oil consumption will expand at a more-than-healthy rate in 2023, with a significant boost in the second half of the year. The IEA has never been more upbeat about this year's demand outlook. It is now at 101.90 mpbd, an increase of 200,000 bpd month over month. In fact, the most recent estimate is exactly in line with OPEC's assessment. Both forecasts represent the highest annual levels. The globe has never required so much oil. Clearly, the war Russia is waging against Ukraine has brought energy security back into focus, and it is fossil fuel that can offer this safety net until the lunacy is done. (Intriguingly, the EIA is the outlier among forecasters, predicting world oil consumption of 100.50 mbpd this year, 1.4 mbpd lower than its rivals. The absolute value is also significantly lower than the pre-pandemic demand forecast of 101.20 mbpd.)

The OECD's energy watchdog predicts a 1.90 mbpd growth in oil consumption, compared to OPEC's projection of a 2.32 mbpd increase. China will account for over half of this increase, with oil demand expected to reach 15.9 million barrels per day by 2022, up from 15 million barrels per day in 2012. This year's oil consumption has been revised up by 300,000 bpd since the country's leadership reversed course and opted to abolish Covid limits. Economic statistics from the world's most populous country will have a significant impact on the global oil demand picture in the future. This picture is now upbeat.

The supply will be abundant in the first half of the year but will fall short in the second half of 2023. Outside of OPEC, countries are forecast to pump 66.45 million barrels per day (bpd) in the January-June period, 300,000 bpd more than was predicted last month. Non-OPEC supply will be 66.85 mbpd in the second half of the year, for an annual average of 66.64 mbpd. The increase from 2022 is 950,000 bpd, or approximately 1 million bpd less than the increase in world oil consumption. What China represents on the demand side of the oil equation, Russia represents on the supply side. It is unclear how international sanctions would effect the country's oil production or how far the invader will go to use oil as leverage, but Russia's output level will be a decisive component of world output. According to the IEA, its crude oil production declined by 30,000 barrels per day in January to 9.77 million barrels per day. Increased exports aided total output, which included condensate and NGLs, to average 11.2 mbpd, only 160,000 bpd less than before the invasion. The IEA, on the other hand, anticipates that about 1 mbpd of production will be shut down by the end of 1Q compared to pre-invasion levels, bringing average 2023 Russian oil output down by 1 mbpd year on year. Russia's developments will have a huge impact on global oil supply and may considerably shape the output policy of the OPEC+ producing group.

The entire impact of China's economic recovery will be felt in the second half of this year. The first half of the year is expected to see a surge in global and OECD equities, thereby presenting an impassable barrier to a long-term price gain. Based on an OPEC output of 29.50 mbpd, global oil stockpiles could increase by 750,000 bpd (the worst will be behind us in 1Q when a build of 1.2 mbpd will be followed by an increase of 300,000 bpd in 2Q). The tendency will reverse by the end of the year. Global oil inventories are expected to fall by 1.45 million barrels per day, bringing OECD stockpiles down to roughly 2.714 billion barrels by the end of the year. Because these are historically low levels, they would be price supporting. Of course, OPEC+ market management will be critical in influencing the global oil balance. At the moment, there is no reason to suppose that the group is in any haste to ramp up output unless prices consistently above $100/bbl. Unless one is a complete believer in the EIA's forecasts, a major price bang is a very possible option later this year.

Russian Roulette 

In Monday's statement, Russia announced a reduction in crude oil production of 500,000 barrels per day beginning next month. The Russian narrative was, at best, eccentric. The country's Deputy Prime Minister, Alexander Novak, identified the G7 price ceiling on Russian crude oil and product exports as the primary reason for the decision, emphasizing that it is an unacceptable intrusion in market relations and calls for retaliatory measures. The action was quickly followed by Russia's own market manipulations, as one of the world's top producers plans to fix the price of its export crude oil at $34/bbl below dated Brent for April, progressively lowering the discount to $25/bbl in July.

The true reason for the reduction in oil production is unknown, and we may never know what it was. There are various conceivable explanations for what appears to be a desperate step. The Kremlin may have concluded that eliminating 500,000 bpd of oil from the market would drive prices much higher and increase petrodollar income. Perhaps it is simply difficult to maintain healthy output levels in the absence of foreign expertise. Finally, while the reduction was presented as voluntary, there is a strong case to be made that Russia is being compelled to lower output out of need as the embargo on its crude oil and oil product exports begins to bite. A related question is whether the move will diminish domestic supplies or effect export volumes. If the former occurs, the price impact will be mild, whereas lowering exports may create some tightness, which may provide a bullish push in the months ahead.

Assuming everything else remains constant, it is worthwhile to re-run the global supply/demand figures based on OPEC estimates, which will be updated today. In the January report, the organization set the call on their oil at 28.35 mbpd for the second quarter, 29.29 mbpd for the third quarter, and 30.20 mbpd for the fourth quarter. Reduced non-OPEC supply by 500,000 bpd beginning in March would raise the OPEC call by the same amount. With 29.50 mbpd of OPEC output throughout 2023, there would still be a stock build in the second quarter, but global oil inventories would begin declining at a quicker rate in the second half of the year. Unless demand falls, the oil balance would tighten significantly.

The inescapable fact is that there would be half a million less barrels of oil available every day, though it is unclear how much of that would be lost. What is becoming abundantly clear is that Moscow requires petrodollars to finance its unwarranted and lengthy war against Ukraine. The country's economy is under severe strain, and it is unable to supply its military with the required financial resources. Since the middle of January, the Russian ruble has fallen 13%, and the stock market has fallen by the same amount since November of last year. According to Russia's central bank, its current account surplus decreased nearly 60% to $8 billion in January as export volumes declined. Russia's budget deficit has risen to $25 billion, with total income down 35%, oil receipts down 46%, and spending up 60% year on year.

European natural gas prices have dropped by more than 80% since their peak in August, a harsh message to Russia that what goes up must eventually come down. Urals is valued more than $30/bbl lower than dated Brent, with a January average price of less than $50/bbl - this year's budget is predicated on $70/bbl. According to the IEA, the economy lost roughly $8 billion in export revenue last month as a result of the sanctions.

Of course, the Kremlin claims that bans and price controls are useless, but the data suggests otherwise. Boycotts of Russian energy sales, as well as financial and technological restrictions, appear to be working. What was expected to be a quick invasion has morphed into a torturous stalemate with time on the side of Ukraine and its allies. And this is most likely the main message of Russia's plan to reduce oil production. That may or may not result in a supply shortage, but it provides the picture of an aggressor who is becoming increasingly desperate by the month. The fact that its future move is unexpected is a big source of concern.

Thanks for reading today's newsletter!