BRENT spot prices and calendar spreads are retreating as traders anticipate the market will be balanced or over-supplied in 2023, after having been under-supplied continuously since the middle of 202o. Business cycle downturns across Europe, Asia and North America are expected to reduce oil consumption absolutely or relative to trend, helping rebuild depleted inventories:
¹ Like any cartel, OPEC+ uses a set of production baselines so total group supply can be adjusted in response to changes in market demand while ensuring each member retains a fair pro rata share. Like other cartels, the baselines used by OPEC+ do not necessarily correspond to shares in actual production or capacity in the real world. Cartels often find it very difficult to reach unanimous agreement to change baselines and shares. So in most cases they end up using baselines that have some historical basis but have become out of date.
Between the 1600s and 1800s, England’s Newcastle coal cartel (known as “the limitation of the vend”) allocated larger shares to some mines than they could actually supply. Some of the older, smaller or higher-cost mines had not been able to grow output fast enough to maintain their traditional market shares. But it was easier to keep the baselines and adjust allocations up and down in line with changing market demand than to renegotiate them. OPEC+ has often faced the same problem.
For both the Newcastle coal cartel and OPEC+, total allocations were often above total supply, ensuring changes in notional allocations were normally greater than changes in actual production.
OPEC+ frames its decisions in terms of adjustments to total and individual allocations, not production. The actual change in production is often different. In this case, many OPEC+ countries have been unable to utilise their allocations fully because they have insufficient capacity. These members will not be required to reduce their actual production since it was already well under quota. The actual fall in production is therefore likely to be much smaller than the reduction in the notional allocations.
The difference between production and notional allocations has been a persistent problem in the oil market. OPEC+ decisions are usually reported as “changes in production” when they should be reported as “changes in allocations”. It may seem a harmless simplification but it is deeply misleading.
Sometimes, however, the misdirection is intentional. It allows OPEC+ to announce a large headline increase or decrease, and use it to generate a desired market or diplomatic reaction, even though the actual change in production is much smaller.
But it is more technically accurate and analytically useful to report OPEC+ decisions in terms of production allocations and then report changes in actual production separately.
U.S. PETROLEUM INVENTORIES fell by -16 million bbl in the week to September 30. There were reductions in crude (-8 million), gasoline (-5 million), distillate fuel oil (-3 million) and jet fuel (-1 million). Total inventories have depleted by -480 million bbl since the start of July 2020 and are now at the lowest seasonal level since 2004:
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EUROPE’s benchmark gas futures price for deliveries in January 2023 has continued to retreat and is now at €176 per megawatt-hour down from €346 shortly before the end of August:
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NORTHWEST EUROPE faces the first test of whether it can lower energy consumption this winter. After warmer than normal temperatures in the first half of September, temperatures were below average in the second half, creating the first significant heating demand earlier than normal:
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U.S. INTEREST RATE traders expected the central bank to increase its target for the fed funds rate to 4.50-4.75% or even 4.75-5.00% by April 2023, up from 3.00-3.25% at present, as policymakers battle to reduce inflation quickly before it becomes entrenched in wage and price-setting behaviour. Rising expected rates are pushing up the dollar’s exchange value, suppressing inflation at home, but intensifying inflation and financial pressure in other advanced economies in Europe and Asia as well as emerging markets:
U.S. DOLLAR has appreciated by almost +9% over the last twelve months against a trade-weighted basket of other major currencies, as the central bank increases interest rates rapidly. The stronger exchange rate will help reduce domestic inflation but will also worsen the trade deficit:
BRITAIN’S CURRENCY has fallen to a record low against the U.S. dollar and is not far above its record lows against the euro, which will increase competitiveness but put upward pressure on the price of road fuel, gas, electricity and other imported items:
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EUROZONE manufacturers reported a further deterioration in business activity this month according to preliminary results from the purchasing managers’ survey. The composite activity index fell to 48.5 in September (24th percentile) down 49.6 in August (28th percentile) and 49.8 in July (29th percentile). The region’s economy is sliding into recession – even before expected energy shortages this winter:
U.S. INITIAL CLAIMS for unemployment benefits are still running at very low rates, with just 213,000 new claims filed last week on a seasonally adjusted basis. Core inflation is unlikely to fall to the Federal Reserve’s target of a little over 2% per year with the labour market this tight – which explains the central bank’s aggressiveness in raising interest rates:
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U.S. CENTRAL BANK is expected to raise short-term interest rates to 3.50-3.75% by February 2023 up from 1.50-1.75% at present to curb inflation. From the second quarter of 2023, however, policymakers are expected to start reducing interest rates as the economy slows and inflation decelerates:
U.S INTEREST RATE traders anticipate a recession has become virtually certain following the continued acceleration of inflation. The yield curve spread between 2-year and 10-year maturities is now in the 98th percentile for all months since 1990:
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Research note originally published in February 2008 when I was working as a market analyst at Sempra Metals. The commodity markets were in the final stages of the super-cycle (which peaked in July 2008) and early stages of a U.S. recession (activity had actually peaked in Dec 2007 but the recession was not yet recognised by most commentators or announced by the U.S. National Bureau of Economic Research until Dec 2008). The note is interesting in retrospect as an example of “real time” analysis around a turning point in the economy and commodity markets:
China boosts coal by rail deliveries by +9% (trans.)
Texas appeals for electricity conservation on July 11
U.S. BUSINESS inventory ratios have started to climb as sales slow and firms struggle to shift extra items ordered on a precautionary basis at the height of the supply-chain crisis. Manufacturers, wholesalers and retailers held inventories equivalent to 1.29 months worth of sales in April up from a cyclical low of 1.26 months in November. Excess stocks are concentrated at the retail level where the ratio has climbed to 1.18 months up from 1.09 months in October 2021.
U.S. inventory ratios remain low by pre-pandemic standards but will climb quickly if sales slow further in response to rapid inflation and a business cycle downturn. Inventory reduction is likely to weigh on economic growth over the next six months as businesses to limit or reverse overstocking:
TEXAS temperatures have climbed well above the long-term seasonal average since the start of July increasing the strain on the state’s isolated electric grid. Cumulative cooling degree days since the start of the year have been almost +30% higher than the 1981-2010 average:
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CHINA’s manufacturers reported a slight increase in business activity this month after lockdowns drove a contraction in April and May but it was not very widespread. The purchasing managers’ index rose to 50.2 in June (31st percentile for all months since 2011) up from 49.6 in May (10th percentile) but it was still down from 50.9 in June 2021 (59th percentile):
U.S. PETROLEUM INVENTORIES including the strategic petroleum reserve fell -1 million bbl to 1,679 million bbl last week. Inventories have declined in 77 of the last 102 weeks by a total of -439 million bbl since the start of July 2020. Stocks are now at the lowest level since October 2008:
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