Oil market fundamentals continue to weaken as Glencore buys

Global oil traders are having lots of fun as oil market volatility ramps up.  Earlier this month, for example, Reuters reported that “Glencore have got big positions all over the place” in North Sea oil markets:

  • They spotted that N Sea production would be sharply reduced in June due to maintenance on the Ekofisk field
  • Reportedly, they already own more than a third of the 37 cargoes expected to load during the month
  • In turn, this means they own around 10% of daily world production – enough to have a major influence on other global markets, given Brent’s benchmark status

Yet at the same time, oil storage is filling up all around the world.  The US surplus is so large that a futures market in storage opened last year, with 25 million barrels now being traded.  And 90 million barrels are currently stored on ships, according to the latest report from the International Energy Agency – 48mb are now being stored off Singapore, for example, whilst tankers are waiting a month to discharge oil at Qingdao in China.

And this oil is costing its owners money to store.  On Friday, the Brent one-year ahead price for July 2017 was only $3.15/bbl higher than today’s price, far below the $10/bbl needed to make a profit.  This contango has more than halved since January, despite all the talk about supply disruptions.

Even more telling is the chart above, showing US prices for coal, WTI oil and natural gas – converted to $/MMBtu equivalent.  The excitement over the recent rally has diverted attention from the fierce competition now developing in US energy markets as natural gas and renewables battle for market share:

  • Coal has been the main loser, with publicly traded coal miners losing almost all their value between 2011 – 2016
  • The largest supplier, Peabody Coal, followed the No 2, Arch, into bankruptcy last month
  • But coal still supplies 34% of US electric power versus 31% for gas
  • And its market share is likely to remains stable as power stations cannot easily convert to other fuels
  • Peabody has therefore been able to raise $800m of bankruptcy financing to continue operating its mines

Oil and gas are also losing market share due to climate change pressures.  The US added more renewable power sources to the grid than gas last year, as major users of electric power such as Google  pressured utilities to use solar and other renewable sources.  Thus gas prices at Henry Hub have actually been below coal prices for the past 3 months – despite it being the winter season – as producers became desperate to sell their product.

This tells us that the current oil market rally is living on borrowed time, due to these supply/demand pressures.  The rally’s only support is from pension and hedge funds – seeking a store of value against dollar weakness – and from traders such as Glencore hoping to exploit short-term production outages in a major market.

But in the end, of course, the fundamentals of supply and demand will set the price.  And when the crash happens, it will be painful, due to the massive supply overhang created by the recent rally.  There are also plenty of potential catalysts for the crash:

  • One is the recent rebound in the value of the US$, as currency traders start to bet that the US Federal Reserve might increase interest rates next month
  • $5tn is traded every day in currency markets, so even a minor rally in the US$’s value would have a big impact on the ”store of value” support

Most traders that I speak to therefore believe that anyone holding large inventories today is playing a dangerous game.  Common sense tells us that it is very easy to build a large position in an over-supplied market.  But experience suggests it is much more difficult to then sell these volumes at a profit, when the market is fundamentally over-supplied.

My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Brent crude oil, down 53%
Naphtha Europe, down 52%. “Additional naphtha is being blended into gasoline for export to the US”
Benzene Europe, down 55%. “The switch to lighter feedstocks among European cracker operators could also help balance out the marke”
PTA China, down 41%. “The new PX capacities that are due to hit the market in 2017 have led to expectations of longer feedstock supply in the
market for PTA producers”
HDPE US export, down 29%. “China distributors were concerned about the competitively-priced cargoes from Iran and Brazil”
¥:$, down 8%
S&P 500 stock market index, up 5%

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