MIDDLE DISTILLATES (focusing here on diesel and gas oil but excluding kerosene and jet fuel) are the most cyclically sensitive part of the oil market. If there is a global economic slowdown in 2023 it will hit distillate consumption hardest. Conversely, if distillate shortages ease it must come about through a slowdown in global growth:
EUROPEAN GAS PRICES are softening throughout the remainder of 2022 and 2023 in response to a near-record refill season, high gas inventories, warmer than average weather forecasts for the first part of winter, and the prospect of reduced consumption from energy-intensive industries:
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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Hertz orders 175,000 more electric vehicles ($WSJ)
CHINA’s railway hauled a record volume of freight in the first seven months of the year. Freight tonne-kilometres were up +9% compared with the same period in 2021 and +22% compared with before the pandemic in 2019. Coal is by far the largest item on the network. The system is moving record quantities of coal from the northern mining areas in Shanxi, Shaanxi and Inner Mongolia to the major consuming centres in the eastern, central and southern provinces:
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INDIA’s coal-fired power plants have 11 days of fuel on hand, an improvement on just 7 days at the end of August 2021, but still slightly below the 13 days at the same point in 2019. The central government has prioritised replenishing fuel stocks to avert a repeat of the power shortages and blackouts that hit the country in October 2021:
U.S. FREIGHT SHIPMENTS accelerated in June after slowing slightly in May. Freight volumes were up +4.6% in June compared with the same month a year earlier. Volumes advanced at the same annualised rate of +4.6% in the most recent three months from March to June. The strong growth was surprising since other manufacturing indicators pointed to a slowdown in activity during the second quarter:
U.S. PETROLEUM INVENTORIES including the strategic reserve rose by +8 million bbl last week, one of the largest weekly increases in the last two years. There were increases in stocks of commercial crude (+5 million bbl), distillate fuel oil (+2 million), propane (+2 million) and other oils (+8 million) partially offset by reductions in jet fuel (-1 million), gasoline (-5 million) and strategic crude stocks (-5 million):
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U.S./China navy competition and Northern Sea Route
EUROPEAN GAS OIL calendar spreads between December 2022 and December 2023 have fallen into a backwardation of less than $11 per barrel from almost $33 in mid-June, as traders anticipate the onset of a recession depressing consumption:
JAPAN LNG STOCKS at the end of May had risen to 2.36 million tonnes, the highest for the time of year for at least seven years, as the country’s utilities accumulate inventories to protect against possible supply disruptions in winter 2022/23:
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China boosts coal by rail deliveries by +9% (trans.)
Texas appeals for electricity conservation on July 11
U.S. BUSINESS inventory ratios have started to climb as sales slow and firms struggle to shift extra items ordered on a precautionary basis at the height of the supply-chain crisis. Manufacturers, wholesalers and retailers held inventories equivalent to 1.29 months worth of sales in April up from a cyclical low of 1.26 months in November. Excess stocks are concentrated at the retail level where the ratio has climbed to 1.18 months up from 1.09 months in October 2021.
U.S. inventory ratios remain low by pre-pandemic standards but will climb quickly if sales slow further in response to rapid inflation and a business cycle downturn. Inventory reduction is likely to weigh on economic growth over the next six months as businesses to limit or reverse overstocking:
TEXAS temperatures have climbed well above the long-term seasonal average since the start of July increasing the strain on the state’s isolated electric grid. Cumulative cooling degree days since the start of the year have been almost +30% higher than the 1981-2010 average:
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United States asks India to restrain Russia oil buying ($FT)
U.S/EU explore options to limit Russia’s oil revenues ($WSJ)
EU/UK ban on insuring Russian oil threatens to raise prices
U.S. gas prices to remain high in 2022 before easing in 2023
China freight volumes and logistics return to normal (trans.)
China sends inspectors to coal regions after prices rise ($BBG)
China threatens to punish “price gouging” (trans.) *
* The warning from China’s State Administration for Market Regulation against price gouging echoes ideas and language employed by the Biden administration and U.S. Congress and the UK Department for Business, Energy and Industrial Strategy. Policymakers in whatever type of government or historical era always try to deflect blame for rising food and fuel prices on to middlemen and traders.
In medieval England, middlemen could be prosecuted under the common law for the offences of forestalling (buying up supplies before they could be delivered to the market), regrating (buying and reselling at a higher price) and engrossing (buying a large proportion of the available supplies to resell them at a higher price). Present-day governments of the United States, the United Kingdom and China would approve.
FREEPORT LNG’s explosion and shutdown is only expected to have a limited impact on the availability of gas in either the United States or the European Union. The premium for gas deliveries in July 2022 to Northwest Europe compared with Louisiana’s Henry Hub has increased to €56/MWh compared with €50 before the incident. But the spread had already shrunk from €100-180 in March in the immediate aftermath of Russia’s invasion of Ukraine.
The market is relatively well situated at the moment to absorb the loss of Freeport LNG exports. Europe has been overbuying LNG and overfilling storage at an unsustainable rate that would have to slow in any event over the next 1-2 months. At the same time, the United States has been overselling LNG, leaving inventories below average for the time of year, implying exports would have had to slow soon.
Even before the Freeport incident, futures prices were starting to enforce an adjustment, with EU prices softening while U.S. prices were climbing to the highest for more than a decade. The stoppage in exports from the facility is accelerating the correction already underway, tempering the need for a larger price adjustment. As a result, the previous weakening of EU prices has been arrested for now, while the prior rise in U.S. prices has been capped for the time being.
The Freeport incident is not expected to have a major impact on gas availability in the European Union. Europe’s gas futures summer-winter calendar spread from July 2022 to January 2023 is still in a near-record contango of more than €11 per MWh, down only slightly from €14 before the explosion, implying the market remains heavily oversupplied in the short term:
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U.S. PETROLEUM inventories including the strategic petroleum reserve rose +3 million bbl to 1,712 million bbl last week. Inventories have risen by a total of almost +5 million bbl in the two most recent weeks after declining by -81 million bbl over the previous twelve weeks:
U.S. DISTILLATE stocks fell by almost -3 million bbl to just 111 million bbl, the lowest for the time of year since 2008:
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Global distillate inventories remain low but have shown some signs of stabilising as the business cycle slows in response to inflation, coronavirus outbreaks and increased uncertainty following Russia’s invasion of Ukraine.
In the United States, distillate fuel oil inventories fell by 3 million barrels to 111 million in the week to April 8, according to high-frequency data from the Energy Information Administration.
Distillate stocks are 28 million barrels (20%) below the pre-pandemic five-year seasonal average and at the lowest level for the time of year since 2008 (“Weekly petroleum status report”, EIA, April 13).
Based on stock movements in previous years, inventories are expected to fall as low as 105 million barrels before the end of June, with the forecast minimum ranging from 97-111 million barrels.
Stocks have been tight since the start of the year but the situation has stabilised since early March with some of the more extreme downside inventory scenarios receding.
High prices for all petroleum products but especially middle distillates such as diesel, heating oil, jet fuel and gas oil are blunting consumption growth.
More importantly, there are signs consumer and business spending has started to decelerate under pressure from inflation, increased uncertainty and supply chain disruptions.
As the pandemic has receded, consumer pending has also begun to rotate from distillate-intensive manufactured products to less distillate-intensive services.
In Europe, too, distillate stocks are low but have stabilised since the start of March in response to high prices and slowing consumption.
Europe’s distillate inventories amounted to just 392 million barrels at the end of March, the lowest for the time of year since 2015, according to estimates compiled by Euroilstock.
But inventories had risen by more than 12 million barrels compared with the end of February, the largest seasonal increase for more than two decades.
The last time stocks rose this rapidly between February and March was in 2008, when surging crude and diesel prices and diminishing economic activity also caused stocks to start rising from a very low level.
In Singapore, stocks have fallen to just 7.6 million barrels, the lowest seasonal level since 2008, and the storage hub is the tightest of all the regions.
Distillates are the most cyclically sensitive of the major petroleum products and a slowdown in consumption growth is normally associated with a mid-cycle slowdown or an end-of-cycle recession.
There are some early signs inventory depletion has slowed or even stopped altogether, with stocks broadly stable since the middle of March, but it will take a few more weeks before any turning point is confirmed.
RECESSION signals are intensifying with the two-to-ten year segment of the U.S. Treasury yield curve within 12 basis points of inverting and in the 88th percentile for all months since 1990. The U.S. economy has been in a formal end-of-cycle recession as defined by the National Bureau for Economic Research for just over 9% of the time since 1990:
U.S. OIL producers have added drilling rigs at a rate of just over 4 per week since the start of the year, essentially the same rate since August 2020, but slower than during the previous recoveries after price slumps in 2015/16 and 2008/09:
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