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Oil’s Recurrent Re-Curving

Summary:
The post-Pfizer vaccine rush pushed most of the contango out of the WTI futures curve. The aftermath of the Georgia Senate vote, and with it dreams of even larger, more carefree fiscal “stimulus”, drained all the rest. As of this week, the entire crude curve is once more contango-free; backwardation front to back.The physical markets have been able to fundamentally rebalance. The major worry had been due to a precarious buildup of gasoline stocks, which, even as seasonal (winter) accumulation sets in, has been successfully surmounted. Inventory levels up to the end of November had been at record levels, the physical market since adjusting such that accumulation so far during the seasonal trend has been lighter than some of the more challenging of recent years (such as last year when

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The post-Pfizer vaccine rush pushed most of the contango out of the WTI futures curve. The aftermath of the Georgia Senate vote, and with it dreams of even larger, more carefree fiscal “stimulus”, drained all the rest. As of this week, the entire crude curve is once more contango-free; backwardation front to back.

The physical markets have been able to fundamentally rebalance. The major worry had been due to a precarious buildup of gasoline stocks, which, even as seasonal (winter) accumulation sets in, has been successfully surmounted.

Oil’s Recurrent Re-Curving Oil’s Recurrent Re-Curving

Inventory levels up to the end of November had been at record levels, the physical market since adjusting such that accumulation so far during the seasonal trend has been lighter than some of the more challenging of recent years (such as last year when the US economy was nearly at, or even in, recession before COVID struck; or the year before in the wake of 2018’s landmine).

Gasoline stocks remain elevated, though, if no longer egregiously so. Small progress is better than none at all.

Further back down the distillate chain, overall domestic crude stocks have likewise rebalanced but not quite in the same semi-satisfying way as gasoline. Inventories of raw material are also high, still among the highest on record, but no longer alone at record issues.

Together, somewhat eased inventory conditions have supported the shift in focus toward what the market hopes is a thoroughly vaccinated, closer to normal future. With supply no longer the big and obvious drag, the entire WTI curve has been able to shift upward by around $8 since early November; in the front months, as contango was purged, by more than $15.

Oil’s Recurrent Re-Curving

The problem, such that there remains one, is that this demand-centered view is entirely future tense. Right now, we are still stuck with an obviously depressed economy. In gasoline, the estimated balance of product “supplied” (a proxy for economic use, or demand) remains catastrophically below any recent yearly comparisons. Like we find in employment data, the economy’s use for gas, in particular, dropped way off in March and then only partially rebounded with reopening in May and June.

Since then, economic demand for this refined energy product has been more or less consistent with the lack of further job growth – as has the shortened rebound in total demand for all energy products.

Oil’s Recurrent Re-Curving Oil’s Recurrent Re-Curving Oil’s Recurrent Re-Curving

Therefore, the only way in which the marketplace has been able to manage inventories from record levels was via continuously curtailed supply. With demand only partially back from the depths, creating a glut of product over the recession’s initial weeks and months, producers have been especially careful to avoid restarting production.

As of last week, the US EIA figures domestic yield remains just about 17% below its March 2020 peak. That’s not just an enormous cutback in production activity, the more noteworthy aspect is the amount of time the supply side has been forced to remain this severely shuttered. Ten months, almost an entire year, with nearly one-fifth of previous output offline represents more than just a major challenge.

Oil’s Recurrent Re-Curving

Realizing that fact, you can see why the WTI curve has behaved entirely according to first vaccine news and then hopes for Democrat-led massive fiscal spending/stipends. Those are really the only things pushing the market higher; in terms of price and curve shape.

Between the end of August up to November 6, the crude market had been stuck in realizing the original “V”-shaped recovery, supposedly boosted and even guaranteed to a certain extent by Fed and feds “stimulus”, had unceremoniously ended. Prices sunk and the futures curve only added more to its front-loaded contango.

From the moment of Pfizer’s initial vaccine announcement, both those price dimensions began to change. The rush back to backwardation was given its second big boost earlier this month when the results of the two Georgia Senate elections were posted.

Oil’s Recurrent Re-Curving Oil’s Recurrent Re-Curving


This crucially indicates the oil market – while recognizing the dead “V” – is now betting that it won’t matter, as much.

The combination of Pfizer/Moderna along with the certainty for Biden’s upcoming use of the government’s prefunded TGA draws (though the amount has fallen under suspicion lately) are being priced as at best a plausible pathway for, and modest renewal of, not quite normal economic function. I believe that’s the part being left out of the Inflation Hysteria #2 as it is elsewhere.

If the overall oil market is projecting a more optimistic view than it was in late October, and it certainly is doing that, it isn’t, however, full-blown inflation-is-just-peaking-around-the-corner. On the contrary, betting on two unknowns aiding demand way over and above the current depressed state of it, the WTI curve even as it restructures into backwardation isn’t even close to its prior backwardation shape from before March.

Oil’s Recurrent Re-Curving


In other words, according to oil, the world is presumed more likely to be less bad assuming everything goes smoothly with vaccinations, and fiscal spending ends up producing this year what it obviously didn’t last year.

Therefore, like the continuously solid demand in the Treasury market, even in backwardation the energy market represents only the modestly reflationary. An improvement, to be sure, though the pressure is now on for both these future factors to live up to their big promises – and do so in a way that last year’s big stuff didn’t.

With the fiscal “hugeness” already stumbling, this modest reflationary hope has already taken a step back in UST’s as longer-term yields are reduced yet again – on top of short-term rates having consistently and un-accommodatively done only that.

Will other markets, including WTI, follow in the same way? Cautious optimism in energy rebalancing itself more the former. Or, more backwardation, continue to project the higher road? Even if it ends up being the latter, there’s no real inflationary recovery scenario in these markets. At their best here, not nearly as bad as last year doesn’t quite have the same pizzazz as all the “V” melodrama had once built up. 

Oil’s Recurrent Re-Curving Oil’s Recurrent Re-Curving

 

Jeffrey P. Snider
As Head of Global Investment Research for Alhambra Investment Partners, Jeff spearheads the investment research efforts while providing close contact to Alhambra’s client base. His company is a global investment adviser, hence potential Swiss clients should not hesitate to contact AIP

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