Oil: The Big 'Switch' in Seasonal Headline Risk

Author: Brynne Kelly 9/05/2022

Worries are growing of an extreme scenario this winter — one that portends natural gas and electricity shortages as their prices continue to hit fresh highs. Europe is at ground zero of this threat. Households and businesses are being squeezed, and politicians have been forced to "act".

Bottom line, the EU has a supply issue. The US and other suppliers are filling the possible shortfall by raising exports which are in turn driving domestic prices higher. Europe is also preparing its population (with a heavy dose of press coverage) to make sacrifices if/when needed.

As professionals we see and appreciate the big risk of the whole supply-side complex, feeling like it will never catch up. But the public, which in some ways includes us since we can't avoid the headlines ourselves either, is being bombarded with seasonal crisis risk. It is hard to separate the two sometimes: the big picture (chronic) inventory and supply problems versus the seasonal crisis potential (we're all gonna freeze!!!) that the press likes to focus on.

The Shift in Sentiment is Happening

Fears of gasoline shortages are now taking a backseat to fears of winter heating fuel shortages. The drama is being played out in the media which is used by policy makers to prepare the general public for the worst case scenario.

As a result, ULSD and Natural Gas futures have maintained their strength while crude oil and gasoline futures are on the decline.

Not Worried about Gasoline anymore, Moving on to Heating Worries...

The last three months have been all about the gasoline crisis. Now that fall is here we are nonstop reading winter risk content. It's the normal seasonal risk changing of the guards. But it is switching at a much higher news volume than usual given the media's relentless semi-knowledgeable focus on our industry like never before.

At the moment the media is being used to raise awareness, modify behavior and manage expectations. The goal is to prepare people for what might be to come this winter.

Let's look at some of the headlines out there to get a feel for this:

• Europe Looks Set for Energy Rationing After Russian Gas Cut

• EU seeks sweeping powers over business for use in crises - Brussels wants bloc to be able to force companies to stockpile supplies and break delivery contracts - FT

• Big energy consumers across the continent are making plans to cut their consumption during winter, when gas and electricity peaks for heating. Some European factories, from steel furnaces to fertilizer makers, are shutting down as the soaring price of electricity and gas has left them unable to compete in the global market.

• Metal Plants Feeding Europe’s Factories Face an Existential Crisis - Power-intensive aluminum smelters say they need government support to survive. In the aluminum industry, closing a smelter is an agonizing decision. Once power is cut and the production “pots” settle back to room temperature, it can take many months and tens of millions of dollars to bring them back online.

• Tens of thousands of Czechs protested in Prague against the government to demand more state help with rising energy bills, the largest manifestation of public discontent over the worst cost-of-living crisis in three decades.

• Soaring energy bills are threatening to put six in 10 British manufacturers out of business, according to a survey that lays bare the extent of the crisis facing the next prime minister.

• £130 bln in energy bill-freezing measures are outlined by UK's Prime Minister Truss.

• Germany “will get through this winter”, said Olaf Scholz as he announced a €65bn (£56.1bn) package to help households and companies manage soaring energy prices, including a windfall tax on electricity producers.

Additionally, on Monday Russia finally admitted what everyone has known since February - namely that it has weaponized commodities in response to the West's dollar weaponization. The Kremlin said that Russia’s gas supplies to Europe via the Nord Stream 1 pipeline will not resume in full until the “collective west” lifts sanctions against Moscow over its invasion of Ukraine.

Ongoing Supply Problems Meet Seasonal Fears

We do have both a chronic big picture problem (supply not responding to higher prices), and a seasonal emerging problem (scarcity pricing as a result of low supply). How this plays out is still up for grabs, just like gasoline season was. But in reality, winter could come and go without fanfare. This could be a result of disappointing weather (we're used to that one), overzealous curtailment of demand (the press loves it) or a combination of both. The seasonal rhetoric has been turned up extraordinarily high for a very real risk. But it is something we face every year in the form of hurricane season and peak winter demand.

Both the ongoing supply risk and the winter seasonal shortage risks are real. But even if the winter does materialize, it isn't like we weren't warned enough times. This is turning into one of the longest runways in history in preparation for the winter heating season. Part of the govt-press role is to prepare people for the sacrifices they might have to make for the upcoming winter heating season. 'Normal' now lies in behavior we haven't seen in the past, so we are being prepared'. We get it, there is the potential of product scarcity this winter.

The point is this: while the risk is real, this is seasonal risk, not winter Armageddon (at least not yet). The news items do not change the weather. And ultimately we see and comprehend the supply situation. The Geo-politics and related headlines create the day to day volatility we are trading around. But the weather, (like Gas demand in summer) is what ultimately matters for the bigger seasonal trades.

Regardless, the stage has been set. The day to day volatility we are experiencing again from OPEC+, Russia, or EU news will certainly play havoc with the price of things. But the markets' real test will be how it reacts to the first whiff of winter weather. This is when we will finally gain some insight to market positioning. Until then, it's a guessing game as to which geopolitical headlines gyrate the markets based on fear and greed, but not freezing cold - it's not freezing cold YET. Regardless, it's out with the summer, and in with the winter we go!

Summer Bullet Dodged

While the focus the last several months has been on gasoline prices and what can be done to move them lower, a series of measures had been taken to do exactly that. A combination of Strategic inventory oil releases, the relaxation of the summer gasoline RVP standards and temporary suspensions of gasoline taxes appear to have done the job.

Continuous RB gasoline futures erase all YTD gains...

The only thing left to keep an eye on in regards to gasoline are inventory levels. As expected, stockpiles generally reach their lowest levels by the end of summer. We have been down here before. But, seasonally these stockpiles increase significantly during the fourth quarter. We expect to see the same pattern this year.

Still low on inventory, but the Summer fear dissipated along with higher prices...

Basically, stick a fork in gasoline as a headliner. The 'price' crisis appears to have been averted (barring any hurricane activity in the next 2 months). It's not even polling that well anymore when doing a quick Google trend search.

Anyway. We are very informed on the risk now.

Winter Gun Loaded

The headline risk has shifted to winter fuels and all the potential crisis that await us. Gazprom is beginning to spike as a trend, given they are ground zero when it comes to natural gas supplies to Europe this winter.

ULSD - aka Heating Oil - as a more transportable liquid energy source than natural gas, is being eyed as a 'proxy' for the winter shortage narrative in the petroleum complex. Unlike gasoline futures, ULSD prices have steadily increased this year, and remain above January levels (below). However, they have been stalling since July. Maybe the market is a little tired of the headlines. Still volatile, yes. Still strong also, given the weakness of the rest of the complex; but directionless for now.

Waiting for Weather Now...

It doesn't help that US distillate inventory levels remain near their lows. In fact, they have been in steady decline since March, 2020. This lends credence to the "undefined vulnerability" - Is there enough time to restock before it gets cold?

Inventories have done a dead-cat bounce so far...

Seasonal Price Trends and Drivers

A continuous futures chart, adjusted for heat content summarizes the above. Natural gas (green line below) and ULSD (red line below) are trending higher while gasoline and oil futures are stalling.

The Energy Complex in Terms of Heat Utility...

Gasoline prices have been governing oil futures direction. But, gasoline cracks are now trending lower while distillate cracks (red line below) are on the rise.

Oil is bound to Gasoline, But Distillates are Looking at Europe....

There is undefined vulnerability that now rests squarely on fuels used to heat homes and generate electricity. Upside remains for ULSD as natural gas and LNG shows no signs of backing off yet. Even natural gas prices on the US east coast are trading well above ULSD in the peak winter months (red line below = Boston City gate NG futures).

ULSD still the cheapest play for substitution...

The US east coast competes with global LNG prices to attract imports during the winter as there is not enough US pipeline capacity to supply New England markets during this peak demand season. New England, however has more capacity to use ULSD as a fuel to make electricity than other parts of the US.

Bottom Line

As stated earlier, the first whiff of cold weather could usher in much higher ULSD prices given natural gas futures. ULSD remains the cheap seat and much hyped. That could just imply that Europe is paying through the nose for Gas like we all did for RB this summer and will ultimately mean little if the winter is mild. What is truly cheap now versus what is expensive depends on how markets react to weather news, not geo-political or Armageddon prep. Normal correlations are on hold and fundamentals have been repealed as far as we are concerned until the first cold snap. Then comes resolution.

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EIA Inventory Recap - Week Ending 8/26/2022

Weekly Changes

The EIA reported a total petroleum inventory DRAW of (7.40) for the week ending August 26, 2022. Commercial inventories however, posted a weekly DRAW of 3.30.

YTD Changes

YTD total petroleum EIA inventory changes show a DRAW of 176.60 through the week ending August 26, 2022.

Inventory Levels

Commercial Inventory levels of Crude Oil (ex-SPR) compared to prior years are have gone from way above historical levels to surprisingly below historical levels and should continue to flounder while backwardation in the market persists. The real 'worrisome' figure is still distillate inventory levels.

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